• A positive meeting between Trump and Juncker temporarily eased trade concerns from a market perspective
• Q2 GDP growth breached 4% for the first time since 2014, and the underlying details were positive for current quarter production
• Higher mortgage rates appear to be weighing on U.S. housing demand
The combination of easing trading tensions, stronger U.S. economic data, and speculation of a hawkish shift from the Bank of Japan (BOJ) contributed to a steeper Treasury curve toward the end of July. The BOJ announced on July 31 that, while it would not be increasing its target yields for Japanese government bonds for the foreseeable future, it would double the allowable deviation from the target yields from 10 basis points (bps) to 20 bps. For example, the BOJ has a target 10-year yield of 0%, and previously it would allow market yields to fluctuate from -0.10% to 0.10% before intervening and purchasing bonds. The 0% target has not changed, but the central bank will now allow 10-year yields to rise to as high as 0.20%. Such an increase could make domestic yields look more attractive to Japanese investors on a currency-adjusted basis, which would be expected to impact demand in other developed markets as well (specifically Europe and the United States). On the trade front, market concerns were lessened following the meeting between President Trump and European Union Commission President Juncker on July 25 to discuss trade relations. While no formal agreements were reached, both parties agreed to good-faith negotiations for freer trade, and so long as those negotiations continue, no new tariffs will be announced. While this positive result alleviated an immediate concern, trade tensions with China remain, and there’s a reasonable risk that President Trump changes his mind on the European truce.
GDP Solid In Q2
The initial estimate of Q2 GDP growth (real) was 4.1% quarter-over-quarter (annualized), the highest rate since 2014. The headline growth rate was just below expectations, but the underlying components appear favorable for growth in the current quarter. Personal consumption (4%) and business investment were both better than expected, contributing 2.69% and 0.94%, respectively, to the overall 4.1% figure. Net exports added 1.1% to headline growth, and this was most likely attributable to front-loading of agricultural exports ahead of pending tariffs (i.e., not likely sustainable). However, a decline in business inventories subtracted 1% from growth in Q2, which is potentially positive for forward-looking production. If consumer demand remains strong, businesses will need to maintain/boost production given lean inventories. The price data revealed inflation holding close to the Fed’s target of 2%.
As mortgage rates continue to creep higher, the rate on a 30-year fixed rate loan is 4.54%, 62 bps higher than a year ago, and as the current economic expansion continues to age, many market participants are wondering if a slowdown in the housing recovery is on the horizon. The June data seem to indicate that the recovery may be fading as demand and supply appeared to be softening. On the demand front, existing home sales fell for the third straight month to 5.38 million units on a seasonally adjusted basis; sales of new homes fell by 5.3% to 631,000 units. Additionally, the May reading was revised lower by 3.3%. This weakening in demand could lead to a continued decline in one of the stronger leading economic indicators, housing starts. The amount of groundbreaking and building permits fell 12.3%, the largest drop since November of 2016. Exhibit 1 plots existing home sales relative to the prevailing rate on a 30-year fixed rate mortgage, and the graph illustrates the impact that rates have on demand.
It is worth noting that month-over-month changes in housing starts tend to be volatile, so the June decline could just be a bump in the road, but the weakness does raise some concern. Recent changes in supply suggest that there could be some resistance on the horizon. For instance, the number of months it would take to clear out the entire inventory of homes increased to 4.3 months from 4.1, the highest level since October of 2016. Additionally, June saw a year-over-year increase of 0.5% in the amount of homes for sale, the first increase in 3 years. All in all, the housing market still appears strong, but some cracks are starting to show and will be something to pay attention to in the coming months.
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