Inflation: Baffling the Fed

Inflation: Baffling the Fed

No rate hike as the Fed struggles to explain persistent low inflation; S&P reacts to China's debt load; Canada's hot streak continues, but with question marks.

“The shortfall in inflation…is more of a mystery [this year], and I will not say the Committee clearly understands what the causes are”
Federal Reserve Chair Janet Yellen, September 20th press conference

The Fed: It’s official As expected, the Federal Reserve’s (Fed) September meeting ended with confirmation that its long-anticipated balance sheet roll-down will begin in October. The meeting also raised the prospect of another rate hike in December, with 12 of 16 members of the Fed’s rate-setting Committee leaning toward such a move in spite of persistently weak inflation data. But longer-term, the median estimate for the target rate in 2019, derived from individual members’ expectations, fell to 2.75% from 3%. For more detail on the Fed’s decision, including comments from managers Brandywine Global and Western Asset, read The Great Unwind Begins.

China: Debt dud Standard & Poor’s (S&P) lowered China’s sovereign debt rating to A+, in line with other top rating agencies Moody’s and Fitch, noting that China’s cumulative debt level might pose risks to financial security. The markets barely noticed. The Shanghai Stock Exchange Composite Index slipped just 24 basis points on the day and the yield on 10-year sovereign debt increased less than 2 basis points. Learn why Western Asset does not see an imminent debt crisis in China.

Canada:  Big growth, but... Canada reported a smaller-than-expected federal budget deficit for the 2016-2017 fiscal year, the latest reflection of the strong growth in the economy. Canada’s GDP grew 3.7% for the 12 months through June 30—its best rate in more than a decade and the highest of any G-7 nation; the annualized growth rate for the quarter was 4.5%—blistering by today’s developed market standards. In response, Canada’s central bank has raised its target rate twice since July (it now sits at 1%), helping its currency to rise 10% versus the US dollar since June. Yet factory sales statistics for July showed a 2.6% drop—much more than expected and the second straight monthly decline. The weakness was largely attributed to excess auto inventory buildup—and pressure on a booming housing market as the government takes measures to cool it off. Further clouding the outlook is a 10% drop in exports in June and July, fully reversing 2016’s gains.

Germany: Electoberfest Ahead of Sunday’s national elections, Germany’s finance ministry announced new data that points to solid economic growth continuing this quarter, even though retail sales, industrial orders and manufacturing output disappointed in July. Not that Chancellor Merkel was in need of any last minute good news—her Christian Democratic Union/Christian Social Union parties are ahead of their biggest rival, the Social Democratic Party by double-digits according to the latest opinion polls. That popularity is not unsurprising given record-high employment, rising real wages and low borrowing costs—economic conditions that favor domestic consumption as well as corporate profitability.


Sources: Bloomberg, Wall Street Journal, Legg Mason


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