Eric Lascelles, chief economist at RBC Global Asset Management analyses the FOMC decision, US GDP, Chinese equities, Gold and Canadian GDP.
FOMC decision: This week’s Fed decision is potentially the end of an era given the prospect of rate hikes starting in the fall. Given the Fed’s data dependency paired with a newfound distaste for forward guidance, it is unlikely that the coming statement will clearly communicate the timing of the first hike. The most useful signal should come from the Fed’s assessment of the economy, which we think will be left roughly constant based on a sequence of mixed data reading and the leak of some cautious Fed staff economic forecasts may be upgraded slightly. As such, we are still slightly disposed toward a September start to the tightening cycle based on our assessment that the economy is improving, models that argue a rate hike is now appropriate and (mild) concerns that a December starting point might be unwise due to low liquidity at that time of year. But too much should not be read into the tea leaves: the Fed itself is likely not yet certain when it will begin, with much depending on second quarter GDP (with annual revisions), and the next two payroll reports.
US GDP: US second quarter GDP should mercifully return to positive territory after a pitiful first quarter. We forecast 3.0% growth, slightly above the market consensus. This should serve to ease fears that the US might be headed into recession, and provide sufficient support for Fed tightening later this year. However, the fireworks may come in another form. The second quarter figures will be accompanied by annual revisions that extend back three years. This is always interesting, but especially so in this particular year because the BEA has promised to at least partially address the “residual seasonality” that has polluted its quarterly GDP data for some time. We see the potential for positive surprises via revisions, for two reasons. First, last year’s revisions revealed better-than-expected growth over the prior year – initial estimates are apparently not fully capturing the true level of output. Second, first quarter GDP was almost certainly not truly as bad as it looks (-0.2% annualized). There is a good chance it is revised into positive territory, and a fair chance that the weakness in the first quarter of 2014 is also tempered. Even if this extra strength has to be taken out of adjacent quarters, we view it as a positive if the economy never shrank and is on a smoother trajectory.
Chinese equities: China’s mainland stock exchanges have suffered extraordinarily losses in the first day of trading this week (-8%). Fundamentally, there is not much to like about this market. Valuations are poor whether evaluated on an absolute basis or versus their Hong Kong-based H-share brethren. The country’s economic growth continues to slow. Much of the earlier market strength was the result of a mix of momentum-seeking private investors and government-induced official buying – both inherently temporary flows. As such, we are skeptical of this market over the medium and long run. However, it is still quite possible that Chinese stocks may first manage new highs in the short run: Access to Chinese equities is indisputably broadening thanks to new international investment conduits and China’s gradual entry into major equity indices. Furthermore, policymaker support should not be underestimated: the Chinese government is taking truly extraordinary steps to support the market, and additional action seems likely.
Falling gold: Gold prices have fallen notably over the past month, to the lowest level in five years. We suspect it will fall somewhat further over the next few years. The classic arguments for high gold prices have always been about inflation fears, risk aversion and quantitative easing. But inflation problems never materialized and market expectations are currently muted. There are still serious risks in the world, but most metrics of risk appetite or aversion seem fairly normal. Finally, the Fed is on the cusp of raising rates, driving a nail into the coffin of North American quantitative easing. To be sure, the ECB and Bank of Japan are still delivering quantitative easing, and the cost of gold extraction is arguably higher than current prices. But the former have never been the key drivers of market sentiment while gold extraction costs are a surprisingly unimportant consideration in the setting of gold prices. As such, a further moderate decline seems likely.
Canadian May GDP: After four consecutive months of declining economic output, we turn to Canadian May GDP with considerable anticipation. The market consensus looks for a 0.0% performance, providing no definitive turn one way or the other. Our own models argue for the barest of positive figures, and thus slightly above consensus. What we can say with greater confidence is that conditions do not at this juncture warrant a “recession” label. The economic decline is not sufficiently deep or broad, and employment has remained resilient so far. Taking a different tact, our composite leading indicator has improved significantly from its low, but remains in a weaker-than-normal position. The oil shock absolutely remains a depressant to Canadian economic growth – particularly given the latest price decline – but this is ultimately consistent with slow growth as opposed to a sharp decline.