In terms of global response to low growth, Japan is perhaps the epitome of the current struggle. In July, the Japanese Bureau of Statistics indicated that inflation in Japan fell 0.4% for the trailing year and inflation ex-food and energy rose merely 0.4%. In June, Japanese household spending fell 2.2% for the past year, worse than expectations. Yet unemployment, by comparison to other countries, remains low at 3.1%. In July, Japan delivered a fiscal stimulus well in excess of expectations designed to address growth and inflation concerns. The Abe government announced a stimulus package of ¥28 trillion (approximately $265 billion), about 40% higher than anticipated. The package is about 5.5% of the country’s annual GDP, similar in relative size to the $800 billion stimulus package that the United States introduced in response to the 2008 crisis.
The Bank of Japan (BOJ) continues to defy expectations. The BOJ was expected to deliver significant monetary policy stimulus to pair with the fiscal stimulus. The central bank nearly doubled the purchases of ETFs from an annual pace of ¥3.3 trillion to ¥6 trillion, but chose not to increase purchases of Japanese government debt or lower deposit rates, falling short of market expectations.
While continuing with current policy, the European Central Bank (ECB) did not make any policy changes at its July meeting. Economic data remains weak with second quarter Eurozone GDP failing to meet expectations at 0.3% quarterly growth versus expectations of 0.6%. Inflation rose to 0.2% in July from 0.1% in June for the trailing year and core inflation did not change from the prior month, remaining at 0.9% for the trailing twelve months. This data has led to speculation of further ECB easing at its September meeting.
In July, the Bank of England (BOE) chose not to increase monetary easing despite concerns of risks to the economy in the wake of the Brexit vote. However, they have acknowledged the potential need to cut their benchmark interest rate from its record low of 0.5% or to reinitiate their quantitative easing in the future. Many expect the August 4th meeting will contain some element of increased accommodation. This marks a meaningful shift for the BOE and casting the BOE in the camp of other developed nations on the easing side of the equation.
In line with expectations, the Fed also did not change interest rates in July. However, the question for the Fed remains around timing of the next hike and it now remains the lone developed market central bank in a modest normalization cycle. While expectations were quashed in June against the backdrop of a weak May jobs report and the global uncertainty introduced by the Brexit vote, the subsequent strong June jobs report and abating of Brexit fears have reintroduced the possibility of a hike this year. Still, expectations continue to shift with economic data, reflecting the uncertainty around timing. The second quarter GDP release at the end of July diminished expectations of a near-term rate hike and Fed Funds Futures implied about a 36% probability of a rate hike by the end of the year. In its July statement, the Fed highlighted that ‘near-term risks to the economic outlook have diminished’ and that ‘labor market indicators point to some increase in labor utilization’, but cautioned that inflation is ‘expected to remain low in the near term’.
In our view, while Brexit and other event risk fear continues to abate, fundamentals remain weak globally. The divide between the U.S. and rest of the developed world continues to widen, particularly in the monetary policy sphere. Even as U.S. economic data continues to oscillate, the baseline is still supportive for investors and anchors global growth. Paired with renewed appreciation for fundamentals versus prior quarters and the large and growing divide between U.S. and abroad, we maintain a constructive view on the environment for high quality U.S. fixed income.
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