Economic and market perspective
Anticipation of monetary policy easing dominated market sentiment during the month, while U.S. data continued to demonstrate greater resilience than consensus expectations.
With approximately half of second quarter earnings reported, earnings have declined about 2.6% year over year according to FactSet, roughly in line with estimates for the quarter, although 77% of reporting companies have beaten expectations to date. If this quarter shows a decline in corporate earnings as projected, it will be the second consecutive quarter with negative earnings growth for the first time since 2016. Third quarter earnings are expected to decline (-1.9%) before a rebound in the fourth quarter (+4.9%) that carries into 2020.
Treasury Secretary Steven Mnuchin traveled to Beijing the last week of July with the goal of advancing trade negotiations with China. These were the most prominent negotiations since May, creating some optimism, and the talks were described as effective and constructive by the Chinese Commerce Ministry. At the same time, President Trump threatened more tariffs on China if an agreement is not reached. The next meeting is scheduled for September in the United States.
With the U.S. expected to hit its debt ceiling in September, concern had been increasing that no deal would be reached and the U.S. government would face the inability to borrow to meet its obligations. However, in July, a deal was reached between President Trump and House Democrats to suspend the debt ceiling until July 2021 and increase spending by roughly $320 billion; the timeline is noteworthy as it will push the issue to after the 2020 election. The agreement is expected to pass the Senate. The White House Office of Management and Budget revised its estimate for the 2019 deficit to $1 trillion.
The Federal Open Market Committee met July 30-31 with markets pricing in a near certainty of a 25 basis point rate cut and the possibility of a larger cut of 50 basis points. Consensus with expectations, the Fed lowered the Fed Funds rate by 25 basis points to a range of 2.00 – 2.25%, citing weak global growth and inflation below its 2% target. This was the first rate cut in the U.S. since 2008. In his press conference, Chairman Powell said that this rate cut was “not the beginning of a long series of rate cuts,” instead referring to the cut as a “mid-cycle adjustment to policy.” He noted, however, that this did not preclude further rate cuts. In addition, the Fed communicated that it will end the balance sheet run-off in August instead of September. As of the end of July, Fed Funds futures projected above a 60% probability of an additional rate cut at the September 17-18 meeting.
The European Central Bank (ECB) did not alter rates at their July meeting, but provided expected hints regarding future accommodation. The ECB indicated that it expected interest rates would remain “at their present or lower levels” for the next year. Supporting this view of coming accommodation, Mario Draghi, President of the ECB, said that “a significant degree of monetary stimulus continues to be necessary to ensure that financial conditions remain very favorable and support the euro area expansion.”
Outlook and conclusions
In our view, while the market focused on the anticipation of policy easing, fundamental data remained resilient and improved throughout July. We expect that the Fed easing will be positive near term for fixed income though somewhat mixed messaging from the Fed regarding the future path of monetary policy has created market uncertainty and could create volatility in the future. The U.S., which had been the outlier among developed nations, has now rejoined the herd in terms of direction of monetary policy. However, the U.S. economy remains relatively stronger than other developed countries, reinforcing fundamental demand for U.S. assets in a global context. While we are mindful of valuations, which have come to reflect much of the positive backdrop, reasonable fundamentals in the U.S. along with the more accommodative monetary policy should be supportive of non-governmental fixed income going forward.