Friday, August 30, 2013

The US data week, tapering and Syria

It wasn’t that long ago that we thought June quarter GDP growth would be the weakest of the year in America.  After the release of the first revision overnight on top of the broader benchmarking revisions in July that lopped a bit of growth off the March quarter, it looks like Q2 will end up being one the strongest of the year.

June quarter growth was revised up from the initial estimate of a seasonally adjusted annual rate of 1.7% to 2.5%.  The market consensus was for a 2.0% result.  That followed growth of 1.1% in the March quarter.  The surprises were a sharp upward revision to non-residential construction while the contribution from inventories was revised up when the expectation was it would probably be revised down.

Other revisions were broadly as expected with net exports revised up and government spending revised down.  Recall the modest fall in government spending in the advance GDP estimate had us thinking there was a risk fiscal drag would take longer to play out.  The revision in government spending from an annualised -0.4% to -0.9% over the quarter reduces that risk somewhat.

Higher growth in Q2 is good news for the Fed as it contemplates tapering its asset purchase program.   More generally however, the data is better described as “mixed”.  Labour market data continues to look good.  Initial jobless claims are at 6-year lows and we think payrolls will print at around +175k in August.  Consumer confidence also printed higher this week.  On the downside, durable goods fell more sharply than expected in July and housing data was a bit softer than expected.  The impact of rising interest rates and its likely dampening impact on the housing market was a topic of some conversation in the July FOMC minutes.

On balance there’s now an element of downside risk to my Q3 GDP growth pick of an annualised 2.2%, but  we continue to expect that growth will be stronger in the second half of the year than it was in the first (1.8% vs 2.4%).   However our forecast leaves the annual rate of growth for calendar just below the FOMCs forecast range.

Tapering is now factored into markets. To that extent the actual timing of when they start is now largely irrelevant.  As I said last week, just getting on with it has the added benefit of removing the uncertainty.  But I still think, given the outlook for growth and inflation, that there is a good chance the FOMC will surprise on the dovish side with the pace of tapering and the assertiveness of its forward guidance.

Finally on the other cause of a bit of market volatility this week: Syria.  Early in the week it appeared intervention was imminent, at the end of the week that was less certain.  Markets have reacted to the news as expected through the week with an initial “risk off” response which reversed during the week as immediate intervention appeared less likely.  The politicians, especially in the UK, are taking an understandably cautious approach.

You will recall that when we do our annual “things to watch out for this year” list, geopolitical tensions always features somewhere on it. From a portfolio perspective that’s why diversification matters.  Given our view on interest rates we are often asked why we maintain an albeit underweight allocation to global bonds.  The answer is it’s still a fragile world, from both an economic and political perspective.  When things go bad, you still want to have an allocation to bonds.  We will be watching developments closely.