The US economy fared relatively well throughout the quarter with some signs of strengthening evident within the economy. US GDP growth remains moderate growing by an annualised rate of 3.9% q/q in Q2, but a significant output gap is still clearly evident. In particular, a combination of a rampantly bullish US dollar and lower crude oil prices has acted as a headwind to economic growth. The buoyant energy sector, in particular, has been hit hard by depressed prices, which has caused a reduction in capex and reduced production activity.
US trade has also been relatively volatile throughout the quarter, as the increasing strength in the US dollar has complicated the delicate balance and impacted US export receipts. Surprisingly, July saw the gap between imports and exports fall by 7.4% from June’s total, to -US$41.9 billion. Exports in July also rose 0.4%, fuelled mainly by a US$303 million gain in industrial supplies and materials, and stronger demand for vehicle parts. In contrast, the trade balance slipped to -US$43.8B in August whilst September saw the gap close to -US$41.9B.
The US labour market has continued to demonstrate robustness with the key Non-Farm Payroll (NFP) results posting gains of 215k, 173k, and 142k for July, August, and September respectively. August’s relatively small result is a statistical outlier and also coincides with a decline in the general unemployment rate from 5.3% to 5.1%. However, the participation rate has remained unchanged at 62.6 throughout the quarter. Also, Gallup reports the US Underemployment Rate, which estimates the number of employees who would desire an increase in working hours, as having increased to 14.5% throughout the quarter.
The PMI results highlight the ongoing structural change that is occurring within the various sectors of the US economy. The Markit Flash US Manufacturing PMI provided some rather subdued returns in September as the 53.0 result remained unchanged from August. The seasonally adjusted result represents a 22 month low and signals one of the slowest rates of expansion, within the manufacturing sector, over the past two years. In contrast, the Services PMI has demonstrated strength, posting gains of 55.2, 55.2, and 55.1 for July, August, and September respectively. The vastly different results between the manufacturing and services sectors highlight the growing importance of the domestic services industry.
The absence of persistent inflation continues to be a major concern within the wider US economy. The unadjusted Consumer Price Index (CPI), a broad measure of price inflation, provided some relatively weak results remaining steady at 0.1% throughout July, August, and September. Consumer demand within the US economy was also relatively weak with Retail Sales declining throughout the quarter and posting results of 0.60%, 0.20%, and 0.20% for July, August, and September respectively. The lack of concerted price inflation and consumer spending is subsequently complicating any move by the US Federal Reserve to tighten monetary policy.
The US Federal Reserve has continued to ruminate over the need to normalise their interest rate policy. The FOMC met in late September to consider raising the targeted Federal Funds Rate from its current level of 0.25%. Despite significant expectation setting in the months before, the FOMC elected to hold rates steady despite the strengthening in US labour markets. However, the Fed made it clear, both within their policy statement and on-going member speeches, that their intent to raise the benchmark rate in 2015 remains. Given the central bank’s focus upon strength in the labour markets it is easy to see the case for monetary tightening. However, inflation forms a key part of their dual mandate and the headline rate is quite a distance from the targeted 2.00%. In addition inflation modelling released by the Fed appears to forecast inflation not returning to the targeted band until at least 2018.
Subsequently, a large part of the case for action rests upon the central bank’s view of the potential risks to a range of asset class valuations by maintaining interest rates at the historically low rate. This view is particularly salient given the amount of quantitative easing injected into the economy which has sought yield in equities.
In response to continual speculation over a rising Fed Funds Rate, currency markets have retained abullish, albeit volatile, sentiment for the US dollar. Subsequently, the US dollar has appreciated strongly against many currencies in emerging markets which further complicates both future monetary policy as well as the outlook for export growth. However, mid-August saw US equity markets tumble, in line with the Shanghai Composite, causing the USD to depreciate against the euro as investors sought a safe haven.
Economic Outlook
The US Federal Reserve’s FOMC sees some significant risks building within the economy, given the tightening labour market, that they are keen to keep ahead of. Recent modelling, released by the central bank, projects the median unemployment rate to dip to 5.0% towards the end of 2015. The labour market is fast approaching the long term natural rate of unemployment, which falls around the 5.0% level, when non-seasonally adjusted. Subsequently, the US Federal Reserve is taking seriously the risk of growing inflationary pressures as the economy moves towards full employment.
However, the decrease in the US unemployment rate is complicated by the increase in flexible arrangements within the domestic labour market. Subsequently, part time and casual employment is on the rise, and the net impact is that wage growth has been relatively static with average hourly wages remaining flat throughout 2015. This complicates the central bank’s ability to forecast inflation accurately given their significant focus upon achieving full employment.
Inflation is likely to remain largely absent throughout the final quarter of 2015 as the US Federal Reserve’s forecasting signals a median PCE inflation rate of 0.4% for 2015. In fact, the central bank’s forecasting fails to show PCE inflation reaching the 2.0% target until 2018. Despite, the lack of persistent inflationary pressures, the US Federal Reserve remains concerned about the long run impact of rates residing near the zero lower bound. Subsequently, projections for the Federal Funds Rate signals a level of 0.40% by the years end, before rising to 1.4% in 2016.
Moving forward, the central bank has taken great pains to signal their intent to hike interest rates before 2015’s close. The public relations blitz following September’s FOMC meeting is unlike anything seen from the US Federal Reserve previously. It is clear that the central bank is viewing the lack of persistent inflation as temporary and rising inflation as a risk in the long term. Recent statements demonstrating their strongly hawkish bias would seem to indicate that their desire to hike rates in 2015 is not solely driven by their dual mandate of full employment and stable price inflation. Given their strong attempts to alter the market expectations towards a rate hike, their credibility will rest upon raising the Federal Funds Rate, regardless of the data, before the years end.
Subsequently, the outlook for the US dollar is going to be strongly linked to any changes in US monetary policy. As we approach October and December’s FOMC meetings, the currency is likely to be relatively volatile with a bias towards bullishness. Any move by the US Federal Reserve to hike rates is likely to see the US dollar rise strongly, especially given the diverging interest rate regimes across the global economy. However, failure to raise rates could see a concerted depreciation as any pricing in of a hike evaporates.
The most likely scenario is continuing volatility for the US dollar, up until the December FOMC meeting, where the central bank may be forced into raising rates 25bps, to maintain their credibility, despite the short term absence of inflation. If this was to occur, a strong and steady appreciation for the US dollar would occur late in the quarter. However, any further surprises in the global macro-economy would place any such scenario at risk.