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Economic data in August was mixed as growth within the business sector was lackluster while the US consumer remained resilient buoyed by steady employment gains and rising wage growth. Second quarter growth was revised lower than previously reported. Commerce Department data showed the economy expanded at a 1.1% annualized rate, from an initial estimate of 1.2%. Consumer spending was the primary driver, growing at a 4.4% clip (from initial estimate of 4.2%), while the biggest downward revisions stemmed from lower business and government spending.
The US manufacturing sector contracted in August for the first time in six months. The Institute for Supply Management’s factory index fell 3.2 points to 49.4, the biggest drop in more than two years. Eleven of eighteen industries surveyed reported weakening operations. Low borrowing costs coupled with limited availability of homes signal continued US housing market strength after purchases of new homes jumped in July to the highest level in nine years. Sales increased 12.4% to a 654,000 annualized pace, the fastest since October 2007.
Sales of previously owned homes dropped in July from a nine-year high in June as the supply of available properties declined 5.8% from a year earlier. Mortgage rates stood below historical levels, as the average rate on a 30-year fixed mortgage was 3.68% in August, below the five-year average of 4.07%, according to Bloomberg data.
US employers maintained steady hiring in August, adding 151,000 jobs, which was below market estimates of 180,000. The unemployment rate stayed at 4.9% for a third month as the labor force increased. Continued momentum in employment gains will add to the Federal Reserve’s (Fed) debate on whether to raise interest rates this year. Chair Janet Yellen said on August 26 that the case for rate hikes “has strengthened.”
US stocks closed relatively flat in August after investors paused to assess the outlook for US interest rates. In addition, a rising US dollar (USD) weighed on commodity stocks. The S&P 500 traded to a new record close of 2,190.15 on August 15, but failed to maintain its momentum amid declining oil prices and speculation over the timing of the next Fed interest rate increase. The S&P 500 eked out a sixth consecutive monthly advance, returning 0.1%. The index was led by financial and technology stocks, while utilities were the laggards. Small cap stocks rallied, with the Russell 2000 index posting a gain of 1.8%, led by energy and technology companies.
For the month, global markets moved slightly higher as the MSCI All-Country World index rose 0.4%, while the developed market MSCI World index increased 0.1%. Euro zone second quarter growth rose an annualized 0.3% from the first quarter, in line with economists’ expectations. The region registered its 13th straight quarter of growth as Germany was the leader offsetting stagnation in Italy. European stocks edged higher led by financials and industrial stocks. United Kingdom stocks posted a third monthly advance. Japan’s second quarter growth was depressed due to a drop in business investment. The MSCI Japan index climbed 0.4%, adding to 2016 gains of 1.1%.
Emerging market stocks rallied in August for the third consecutive month, advancing 2.5%. Developing stocks in Asia increased 4.1% amid better than expected Chinese economic data. China’s official factory gauge rose to 50.4 in August from July’s 49.9 while the gauge of non-manufacturing activity stood at 53.5 compared to 53.9 in July.
Crude oil prices closed August at $44.70 per barrel; an advance of 7.5% amid speculation members of the Organization of Petroleum Exporting Countries (OPEC) may discuss actions to try to stabilize the oil markets. Gold fell 3% after hawkish Fed comments raised the prospects of higher interest rates in September.
Comments by Fed officials during August led investors to increase expectations for an interest rate hike this year, sending US Treasury (UST) yields higher and prices lower for the first time since April. UST 2-year yields, the most sensitive to the monetary policy outlook, climbed 15 basis points (bps) for the month to 0.81%, the largest monthly gain since November 2015. UST 10-year yields climbed 13 bps to 1.58% as three straight monthly gains ended in August for the BofA Merrill Lynch US Treasury index, declining 0.57%.
US investment grade corporate bonds advanced for a third straight month as spreads to UST yields narrowed to 121 bps from 130 bps in July. Spreads on US high yield corporates tightened 52 bps to 473 bps as average yields declined to 6.31% from 6.71% contributing to a monthly gain of 2.1%. The energy sector outperformed, posting a monthly return of 4.2%, as average yields fell to 8.32% from 9.21% for the month and down from 15.75% at the start of 2016.
European sovereign bonds declined in August after the first monthly rise in yields since April. Average yields on the BofA Merrill Lynch Euro Sovereigns index rose 2 bps to 0.19%. German 10-year yields rose to -0.07% from -0.12% at the end of July. Italian 10-year yields declined 2 bps to 1.15%, while identical yields on Spanish bonds fell 1 bps to 1.01%. The European Central Bank’s previously announced inclusion of European corporate bonds in its monthly bond purchases continued to provide support. The BofA Euro Corporate index rallied for an eighth consecutive month in local currency terms, but declined slightly in August in US dollar terms. In an effort to help boost the United Kingdom’s economy, the Bank of England cut interest rates by 25 bps to 0.25%, the first cut since March 2009. The 10-year UK gilt yield declined to 0.52%, the lowest since 1994, before closing the month at 0.64%.
Emerging market bonds rallied as signs of improving developing country economic prospects and stabilizing commodity prices increased investor appetites for higher yielding fixed income. The premium to own EM USD sovereign bonds over UST declined to 361 bps in August from 392 bps in July.
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