Weekly Market Review: No holiday for economic news

We review four key events from last week, and preview what’s ahead

Weekly Market Review: No holiday for economic news

Though the US and Canada kicked off July with national holiday celebrations, market and economic news didn’t take a break. In contrast, investors received four key pieces of information last week that could influence markets going forward. And we look ahead to important events that promise to create headlines this week.

1. The positive jobs report bodes well for the economy

The highlight of last week was the positive jobs report from the Bureau of Labor Statistics. Nonfarm payroll creation was robust at 222,000, driven by growth in a variety of industries including health care, professional and business services, and food services. And there were upward revisions to the previous two months’ nonfarm payrolls as well. We even saw slight improvement in labor force participation. All in all, this report suggests the economy is humming along and the jobs recovery has legs.

Arguably the one area of weakness in the employment situation report was wage growth, with average hourly earnings rising a tepid 0.2% for the month and 2.5% for the year. And that metric calls into question the Phillips Curve, which is the theory that there is an inverse relationship between unemployment and inflation. This relationship would suggest that, in a tight labor market, employers would have to pay more for the workers it hires. This does not seem to be the case — at least not yet.

2. FOMC members continue to debate inflation

Also released last week were the minutes from the June Federal Open Market Committee (FOMC) meeting. They revealed a continuation of the inflation debate that has been playing out in recent speeches by Federal Reserve (Fed) officials — specifically, whether lower inflation is transitory. Chair Janet Yellen and other members of the FOMC believe that it is. The minutes indicate that “most participants” attribute recent lower inflation to “idiosyncratic factors” such as lower wireless service costs and lower prescription drug prices and therefore we should not see an impact to inflation over the medium term. Their view is that the recent spate of lower inflation is not something to be worried about because a tighter labor market will beget higher wage growth. However, as we saw with the June employment situation report, we’re not experiencing that phenomenon yet. This may create even more confusion around what the Fed will do in the coming months. While it has reached its unemployment rate target, it is further away from its inflation target.

Adding to the complexity of the situation is that the Fed will be operating two different monetary policy levers when it begins the process of balance sheet normalization in addition to hiking interest rates. (As I explained in my June 19 blog, I believe balance sheet normalization has far greater potential to affect markets than rate hikes.) While the FOMC minutes indicated that the Fed could announce the start of balance sheet normalization soon, I believe that probably won’t happen before the September FOMC meeting — the Fed will probably want to wait and see how Congress handles the upcoming possibility of a debt ceiling crisis. (Some members have even advocated waiting until later in the year to decide on the start of normalization in order to further assess economic activity and inflation.) Having said that, the Fed seems likely to start the balance sheet normalization process before the end of the fourth quarter of 2017 unless conditions change significantly.

3. The ECB charts a gradual course toward tapering

Perhaps more important than the FOMC minutes were the European Central Bank (ECB) minutes from its June meeting, which were also released last week. They suggest that the ECB is preparing to begin tapering its asset purchases soon — but only very gradually. The ECB also agreed to remove its previous statement that it might cut rates in the future. While a tiny step, it is symbolic of a larger change. Markets seem to be reflecting a growing realization that central bank accommodation has peaked, with yields increasing on Treasuries, bunds, gilds and other sovereign bonds last week.

4. North Korea claims the ability to reach the US with a nuclear missile

The worst news of the week is geopolitical in nature — and it concerns North Korea. Perhaps not coincidentally, on July 4 — as US citizens celebrated their nation’s Independence Day — North Korea demonstrated its ability to fire a nuclear-capable missile that can reach the United States. This marks a new era for the United States, as other North Korean missile tests had a shorter range. The US now joins the list of countries that live within striking distance of a hostile nation.

There seem to be few if any good options available to the United States. President Donald Trump’s strategy seems to be focused on utilizing China to intervene and encourage North Korea to stand down. However, China has a very unique relationship with North Korea; it behooves China to have North Korea remain strong. Otherwise, if North Korea were to weaken, it might reunify with South Korea and form an economic powerhouse — which would not be in China’s best interest. In addition, China may be reluctant to help the US given it is not happy with President Trump’s current stance on trade. Chinese President Xi Jinping recently admonished the United States on the dangers of de-globalization in response to the US president’s calls for protectionism. In addition, President Trump’s tweets have the potential to create confusion at a time when UN Ambassador Nikki Haley and Secretary of State Rex Tillerson are trying to delicately manage the situation.

Looking ahead

Looking ahead, much is being released this week in the way of economic data, including two important US inflation measures as well as US retail sales and US industrial production.

However, all eyes should be on Fed Chair Yellen’s testimony to Congress. In the Fed’s Monetary Policy Report released on Friday, we got a preview of what will likely be one of the key areas that legislators will question Ms. Yellen about: rules-based monetary policy. This is an important debate as having policy rules could limit the flexibility of the Fed to react to nuanced changes in economic conditions. Other important topics during her testimony could include her concerns about asset price increases (and if they are nearing a “bubble”), the debate over whether lower inflation is transitory, and some details on balance sheet normalization.

Additionally, with the ECB preparing to reduce accommodation ever so slowly, I’ll be watching to see the reaction of international stocks. If they experience queasiness, that could present an attractive buying opportunity for many investors, given that the fundamentals of many international stocks are solid and the economic backdrop is improving.

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Important information

Blog header image: kmichal/Shutterstock.com

The risks of investing in securities of foreign issuers can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.

All investing involves risk, including risk of loss.

The opinions referenced above are those of Kristina Hooper as of July 10, 2017. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.

Kristina Hooper
Global Market Strategist

Kristina Hooper is the Global Market Strategist at Invesco. She has 21 years of investment industry experience.

Prior to joining Invesco, Ms. Hooper was the US investment strategist at Allianz Global Investors. Prior to Allianz, she held positions at PIMCO Funds, UBS (formerly PaineWebber) and MetLife. She has regularly been quoted in The Wall Street Journal, The New York Times, Reuters and other financial news publications. She was featured on the cover of the January 2015 issue of Kiplinger’s magazine, and has appeared regularly on CNBC and Reuters TV.

Ms. Hooper earned a BA degree, cum laude, from Wellesley College; a J.D. from Pace University School of Law, where she was a Trustees’ Merit Scholar; an MBA in finance from New York University, Leonard N. Stern School of Business, where she was a teaching fellow in macroeconomics and organizational behavior; and a master’s degree from the Cornell University School of Industrial and Labor Relations, where she focused on labor economics.

Ms. Hooper holds the Certified Financial Planner, Chartered Alternative Investment Analyst, Certified Investment Management Analyst and Chartered Financial Consultant designations. She serves on the board of trustees of the Foundation for Financial Planning, which is the pro bono arm of the financial planning industry, and Hour Children.

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