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The moderate pace of economic growth during the fourth quarter of last year spilled over into the first quarter of 2016. The economy expanded at its slowest pace in two years, held back by reduced consumer spending and a slump in corporate spending resulting from weak global demand. The economy grew at an estimated 0.5% annualized rate after the modest 1.4% fourth quarter advance. Household purchases, which account for almost 70% of the economy, rose at a 1.9% annual pace, compared with 2.4% last quarter. The downturn in corporate spending weighed heavily on growth, as spending on equipment and structures dropped at a 5.9% annualized pace, the largest decline since the second quarter of 2009.
Federal Reserve (Fed) policy makers maintained their view that economic activity would expand at a moderate pace and labor market indicators would continue to strengthen after keeping the target range for the federal funds rate at 0.25% to 0.50%. Although labor market conditions strengthened, they noted “market-based measures of inflation in compensation remain low.” The employment cost index (ECI), that tracks wages and benefits for private industry, climbed 1.9% over the past 12 months, the smallest gain in two years. Moreover, the Fed expects inflation to continue to track below its 2.0% target in the near term due to prior declines in energy and import prices.
The impact of a strong US dollar and weak global demand continues to restrain US manufacturing activity as the Institute for Supply Management’s (ISM) factory index declined to 50.8, barely above the 50 level that indicates expansion.
Euro area first quarter growth (+0.60%) was the fastest in a year and unemployment in March was the lowest since 2011. However, there was a renewed decline in consumer prices as the annual inflation rate fell to -0.2% in April, signaling the European Central Bank’s (ECB) efforts to stoke inflation have yet to materialize. Japan’s headline inflation fell 0.1% in March from the previous year, down from February’s 0.3% rise while core inflation, excluding food and energy, rose 0.7%, down from February’s reading of 0.8%.
US equity markets edged higher in April, following strong gains in March. The S&P 500 reached a four month high on April 20, coming within 1% of the record close set in May 2015. Six of the S&P 500’s ten sectors rose, led by energy companies that benefited from a rally in oil prices. Technology stocks lagged due to disappointing first quarter earnings reports. First quarter corporate earnings were at the forefront, as more than half of S&P 500 members have reported earnings, with 74% beating profit forecasts and 41% exceeding sales expectations. Mid and small cap US equities outpaced large caps, as both the Russell MidCap and Russell 2000 climbed over 1.0%.
Global equities rose sharply in April buoyed by a weaker US dollar (USD) and a more dovish tone from the Fed. European stocks advanced, as the benchmark Stoxx 600 index touched its highest level since January, before a stronger euro and mixed earnings releases prompted profit taking prior to month end. The Stoxx 600 rose 2.4% (USD) led by a surge of nearly 14% in materials stocks. Japanese equities tumbled on the final day of trading after the Bank of Japan (BoJ) unexpectedly kept its bond buying and negative interest rate policies in place. Investors had expected additional easing measures to be announced. Despite these last minute trading pressures, the Nikkei 225 index posted a gain of 3.3% (USD) for the month of April.
Emerging market stocks and currencies advanced in April. Currencies were supported by higher commodity prices, which benefited commodity exporters such as Russia and Columbia. The MSCI Emerging Markets Currency index rose 0.9% in April, following a 5.2% gain in March. The Russian ruble climbed higher after central bank policy makers signaled they may look to cut interest rates in the near term. Brazilian stocks advanced for a third consecutive month amid speculation a new administration might assume power and help lead the country out of recession.
Signs of stabilizing economic growth in China and declining US crude oil production led to outsized gains in commodity prices, as the Bloomberg Commodity index returned 8.5% for the month. Oil prices rebounded nearly 20% to $45.92 per barrel, while gold reached its highest level since January 2015.
Bond investors turned positive after the Fed signaled a more gradual and data dependent path for interest rate normalization. Markets have pushed out expectations for when the Fed will next tighten monetary policy. Futures show investors assign only a 12% probability that the Fed will boost borrowing costs by June. However, they price a 60% chance of a rate hike by December, per Bloomberg data. The trend of US Treasury yields in April was reflective of the uncertainty regarding the outcome of the Fed meeting. Overall, US Treasuries posted a monthly decline for the first time in 2016, as the BofA Merrill Lynch US Treasury index lost 0.1%. US corporate credit spreads narrowed during the month. The spread on the Barclays US Corporate Investment Grade index fell to 146 basis points (bps) from 163 bps in March, as the index gained 1.4% in April. The Barclays US Corporate High Yield index rose 3.9%, after spreads dropped to 577 bps from 656 bps at the beginning of the month.
Euro area government bond yields found little support in the first month of the ECB’s expanded monthly bond purchase program that was increased to €80 billion from €60 billion. Germany’s 10-year bond yield rose to 0.27% from 0.15% in March. Italy’s 10-year yield rose 27 bps to 1.49%, while Spain’s 10-year yield jumped to 1.59% from 1.44% in March. Yields on UK bonds increased ahead of a referendum on European Union membership. Recent polls showed the projected outcome of the June 23 vote was too close to call prompting foreign investors to exit UK bond positions in April. The 10-year UK bond yield jumped 18 bps to 1.60% from the end of March.
The combination of a weaker USD and a softer tone from the Fed helped boost investor risk appetites, leading to a rally in emerging market debt in April. The spread over US Treasuries on the JPMorgan EMBI Global index reached 538 bps on February 11, the highest since May 2009. From that point forward, declining yields drove the spread down to 410 bps by the end of April. For the month, the emerging market index gained 1.9% (USD), the third consecutive monthly gain. Yields on local currency emerging market debt have also declined. The average yield on the JPMorgan GBI-EM Global Diversified index fell 13 bps to 6.38% from the end of March, resulting in a monthly gain of 2.6% (USD) for the index.
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