07.29.19

The ECB disappoints. U.S. GDP doesn’t.     

Brian Nick

The last week’s market highlights:

Quote of the week:

“If you expect nothing from anybody, you’re never disappointed.” – Sylvia Plath            
 
Each week, we present our featured topics in the context of the major themes listed below from Nuveen’s Midyear Outlook :
 
  • U.S. economy: Late cycle but no recession
  • Global economy: Still looking for a bottom    
  • Policy watch: Easy monetary policy to offset restrictive trade policy  
  • Fixed income: Volatile interest rates but no breakout in either direction 
  • Equities: Get defensive, stay invested 
  • Asset allocation: No longer “risk on,” but still prefer emerging-market bonds  

Policy watch: The ECB pulls out its “teaser” gun   

Heading into last Thursday’s European Central Bank (ECB) meeting, investors increasingly expected ECB President Mario Draghi and his colleagues to launch fresh stimulus measures. That’s because on top of the eurozone’s sluggish second-quarter economic data, the region’s purchasing managers’ indexes (PMIs) for July, released the day before the meeting, revealed that:
  • Eurozone business activity declined to 51.5, edging closer to the 50 mark separating contraction from expansion. Manufacturing slid to a 6½-year low.
  • Manufacturing activity in Germany, the eurozone’s largest economy, fell further into contraction territory (43.1).
  • The French manufacturing PMI also slipped, to 50. France is the region’s second-largest economy.  
 
The PMI releases also noted that rising concerns about trade wars, weakened economic growth prospects—both locally and globally—and Brexit-driven geopolitical stress have continued to weigh on eurozone business sentiment. Separately, the Ifo Institute reported that gauges of business optimism in Germany plunged to multi-year lows in July.    
Against that backdrop, investors initially cheered the ECB’s policy statement, which stated that the region needed “a highly accommodative stance of monetary policy for a prolonged period of time.” Global equities and sovereign bonds rallied. And much to the ECB’s approval, the euro declined to around 1.11 versus the dollar, approaching the common currency’s lowest point since May 2017. With Eurozone inflation undershooting the ECB’s 2% target for years, this drop was welcome. A weaker euro not only boosts prices but also make exports more competitive.   
 
But the good news was short-lived. In his press conference, Draghi failed to provide concrete steps for jumpstarting growth. He mentioned reducing already record-low interest rates and launching another round of quantitative easing (QE), most likely following the ECB’s upcoming September meeting. Draghi’s vague and underwhelming details underwhelmed markets. The euro rebounded, stocks relinquished their gains to finish the day in the red and bond yields rose.    
 
Why did investors turn a cold shoulder? A lack of credibility, perhaps. The ECB has been adept at raising expectations but not always at delivering. Another possibility is Draghi’s “lame duck” status. His term expires in October, when he will be replaced by current International Monetary Fund President Christine Lagarde. While she’s expected to stick to the ECB’s policy path, she’ll have limited firepower at her disposal. Not only does the scope for meaningful interest-rate cuts seem limited, but QE has failed to raise eurozone inflation significantly.      
 

U.S. economy: Amid the July heat, we’ll take this cooldown in GDP  

According to the government’s advance estimate, released on July 26, the U.S. economy grew at a 2.1% annualized rate in the second quarter, slightly above consensus forecasts but well below its first-quarter pace. 
 
Among the positives:
 
  • Consumer spending, which accounts for about 70% of GDP, grew at a 4.3% annualized rate. This marked a major improvement over the first quarter, when it rose just 1.1% as the government shutdown left some 800,000 people without a paycheck for most of January. For the two quarters combined, the roughly 2.7% growth provides a reasonable picture of consumer activity: solid, not spectacular, but certainly good enough to keep the U.S. out of recession.
  • Government spending added impressively in the second quarter, with about one-third of its contribution coming from state and local governments’ infrastructure projects.
 
Negative impacts included:
 
  • Private investment, which registered its biggest quarterly contraction (5.5%) since 2015.
  • Inventories suffered their worst drawdown in a year. Producers failed to rapidly restock their shelves.
  • Trade, as soft global growth led to a drop in exports.   
 
So what’s our outlook for U.S. GDP?
 
If we see consumer spending growth of around 2.5%, partially offset by modest declines in investment, trade and government spending, the economy could continue to chug along at a 2%-2.5% annualized pace. This is what markets have come to expect during this long recovery, which began in 2009. Indeed, 2% GDP expansion over the balance of 2019 seems about right to us.
This material is prepared by and represents the views of Brian Nick, and does not necessarily represent the views of Nuveen LLC, its affiliates or other Nuveen staff.
 
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