Central banks might have to be very creative to maintain economic growth in the next few years.
Global markets jumped Tuesday after European Central Bank (ECB) President Mario Draghi indicated more monetary stimulus was likely on the way. Only a few months ago, the ECB president was talking about ending the bank’s asset purchase program and perhaps raising interest rates.
Since then, economic weakness throughout Europe raised concerns about a recession. Interest rates have declined, indicating investors see the economy as weak.
A similar course of events took place in the United States when the Fed put its tightening policy on hold early in 2019. Now the only question among investors is when the Fed will act to stimulate growth.
While these announcements from the Fed and the ECB pushed markets higher, investors who take a longer-term perspective are more cautious.
The U.S. economy still is growing at a modest rate. The labor market is very strong. While manufacturing and housing data have been weaker for the most part in recent months, other economic data are strong. The service sector continues to do well, and recent retail sales data have been strong.
In the past, the economy had to be much weaker than this for the Fed to consider reducing interest rates or taking other steps to stimulate the economy. It is a warning sign that the Fed is considering taking action, and the markets want it to, when the economy still is growing. In addition, the central banks don’t have a lot of policy options open to them.
Interest rates remain near historic lows in both the United States and Europe. In many European countries, rates are negative. Central banks can’t reduce interest rates very much.
There also are limits to the asset purchases the Fed and ECB can undertake. They purchased a lot of assets in the past and still have large balance sheets. There aren’t that many assets left for them to purchase.
Another problem: In the years since the financial crisis, these measures became less effective each time they were used. If the central banks use them now and the efforts have little effect, what will central banks do in the next recession?
Ideally, fiscal policy would be coordinated with monetary policy to prevent a recession. But we have a divided government in the United States. Thus, a bipartisan fiscal policy to keep the economy growing is unlikely. In Europe, each country develops its own fiscal policy. A coordinated fiscal policy is unlikely there as well.
But fiscal policy changes are what the global economy needs. The global economy isn’t suffering from a lack of liquidity. There’s plenty of private sector financing available to replace what the Fed withdrew in 2017 and 2018.
The problem is the unwillingness of businesses to spend money to expand, because they don’t believe there is adequate demand for additional products and services. Consumers are more cautious about spending and borrowing than they were before the financial crisis.
Faced with this situation, central banks will have to be creative if they want to increase economic growth and avoid a recession. Academic and private sector economists have been publishing some ideas. So far, the central bankers aren’t talking publicly about what new measures they might take or when they might be tried. This is another reason to be sure your portfolio is balanced and each of your investments has a margin of safety.
Last Friday’s Retail Sales report for May was a strong one. Sales increased 0.5% for May. April’s sales initially were reported as a 0.2% decline, but that was revised higher to a 0.3% increase.
However you slice the data, even by excluding autos and gas, sales increased solidly in May and April.
Retail sales are volatile from month to month. The increase in sales over the last several months is solid, and they’ve recovered from the sharp decline that was reported in December. The strong retail sales also are consistent with the high levels of consumer confidence reported in recent months.
Industrial Production staged a modest recovery in May, increasing 0.4% following a 0.4% decline in April. The manufacturing component increased 0.2%, compared to a 0.5% decline in April.
But manufacturing in the New York area tumbled, according to the Empire State Manufacturing Survey. The index was reported at a negative 8.6 compared to a positive 17.8 in May. That’s the worst level for the index since October 2016 and the worst one-month decline in the history of the measure, which began in 2001.
The Philadelphia Fed Business Outlook Survey also reported a sharp drop in activity. The index declined from 16.6 in May to 0.3 for June. Most of the components of the index were in positive territory but were lower than in May. The six-month outlook in the survey is positive but at the lowest level since early 2016.
Home builders are a little less optimistic this month, according to the Housing Market Index from NAHB. The index declined to 64 from 66. That’s still the second highest level since October 2018. The level still points to improvement in new home sales.
Consistent with that report, housing starts increased in May, though permits for new houses declined a little. Also, the starts previously reported for March and April were revised much higher. The negative part of the report is that apartments were the bulk of the new starts. Single-family home starts still are slowly recovering from 2018’s decline and are down 12.5% over 12 months.
Consumer Sentiment, as reported by the University of Michigan, declined to 97.9 from 100.0. This still is high by historic standards. Most of the decline was due to uncertainty over the consequences of tariffs and trade conflicts.
New unemployment claims declined by 6,000 to 216,000. The four-week moving average increased by 1,000 to 218,750 because of increases the previous two weeks.
The S&P 500 rose 1.62% for the week ended with Wednesday’s close. The Dow Jones Industrial Average increased 1.96%. The Russell 2000 added 2.39%. The All-Country World Index (excluding U.S. stocks) grew 1.78%, while the emerging market equities soared 2.33%.
Long-term treasuries rose 1.42% for the week. Investment-grade bonds increased 1.66%. Treasury Inflation-Protected Securities (TIPS) added 0.67% and high-yield bonds grew 1.18%.
A review of currency changes showed that the U.S. dollar climbed 0.34%.
Energy-based commodities rose 3.05%. Broader-based commodities gained 1.73% and gold increased 1.65%.
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