News of the week summary - 07/28/2024
US economy exceeds expectations
In a surprising turn, the US economy expanded at an annualized rate of 2.8% in the second quarter, exceeding expectations of 2% and reflecting the continued strength of consumer spending. This strong growth comes as the Federal Reserve contemplates the timing of potential interest rate cuts in the coming months.
The Federal Reserve (Fed) has recently raised interest rates to a 23-year high, ranging between 5.25% and 5.5%, as part of its efforts to combat inflation. With inflation easing to around 3% in June, the central bank faces the challenge of determining the right moment to begin lowering rates without jeopardizing the economic recovery.
Market reactions were mixed following the GDP report, with futures traders slightly reducing their bets on imminent rate cuts. However, there is still widespread anticipation that the Fed will lower rates two to three times before the year ends.
One critical measure of domestic demand, which excludes inventories, trade, and government spending, rose by 2.6% in the second quarter, maintaining the same pace as in the first quarter. Consumer spending, a significant driver of the economy, increased by 2.3%, up from 1.5% in the previous quarter. This suggests that while consumers are still spending, the pace may be slowing down. However, despite the positive GDP data, recent job market reports indicate some softening, which could strengthen the case for a rate cut soon.
Federal Reserve officials have been preparing the groundwork for a potential rate cut as early as September. Fed Chair Jay Powell recently highlighted the encouraging trend in inflation, suggesting that the economy might achieve a “soft landing,” where inflation returns to target levels without triggering significant job losses. Although layoffs are on the rise, pushing the unemployment rate above 4%, it remains low by historical standards.
The US continues to outperform other advanced economies, with the IMF forecasting a 1.7% growth for these nations in 2024, compared to a global projection of 3.2%. President Joe Biden lauded the GDP report, declaring that the US now has the “strongest economy in the world,” citing job creation, rising wages, and declining inflation as key achievements.
US tech stocks dip after Tesla and Alphabet miss targets
The Nasdaq Composite Index dropped 2.8% by early afternoon in New York, with Alphabet, Google's parent company, down 5.1%. Although Alphabet narrowly exceeded revenue forecasts, advertising revenue from YouTube fell short of expectations, triggering investor concern. Tesla's stock plummeted by 10% after the electric vehicle manufacturer's profits missed projections, marking its largest one-day decline since January.
This sell-off is part of a broader trend where investors are moving away from tech stocks, which had been bolstered by excitement over artificial intelligence (AI). Instead, they are now turning to smaller, less-favored companies. The Nasdaq is down over 5% from its July 11 peak, a decline that began when lower-than-expected U.S. inflation data sparked a rotation in market preferences.
The recent performance of Alphabet and Tesla has heightened worries that the stock market may be overly dependent on a handful of big tech companies, often referred to as the "Magnificent Seven." Tesla's outlook, in particular, has drawn skepticism, due to doubts about the timeline and success of its ambitious self-driving "robotaxi" program. Elon Musk, Tesla’s CEO, recently delayed the launch of these vehicles from August to October but suggested that, if successful, the project could eventually boost the company’s valuation to $5 trillion—about six times its current value.
The decline was not limited to Tesla and Alphabet. Other members of the "Magnificent Seven" also saw significant drops: Nvidia, a leading chipmaker, fell nearly 4%, while Facebook's parent Meta, along with Apple and Microsoft, each saw declines of around 3%. The broader market also felt the impact, with the S&P 500 dropping 1.7%. Meanwhile, the Russell 2000 index, which tracks smaller companies too, fell only 0.2%, buoyed by hopes of potential interest rate cuts by the Federal Reserve as early as September.
In response to the tech sell-off, investors flocked to safer assets like U.S. Treasuries. The yield on two-year Treasuries, which are particularly sensitive to interest rate expectations, fell by 0.05 percentage points to 4.39%, its lowest level since February.
Sharp decline in business confidence in France and Germany fuels expectations of ECB rate cuts
The economic outlook in France and Germany, the Eurozone’s largest economies, has taken a negative turn as business confidence drops significantly. This downturn has heightened expectations that the European Central Bank (ECB) may cut interest rates in September to counteract a potential slowdown in the broader Eurozone economy.
In response to the deteriorating business sentiment, German two-year bond yields fell to a five-month low of 2.67%, as investors increasingly bet on the ECB cutting rates at its upcoming meeting on September 12. However, this decline in yields was partially reversed due to positive economic growth data from the United States.
The dip in confidence was underscored by recent data from France, where the national statistics agency, Insee, reported a drop in its business confidence index from 99 to 94, marking the lowest level in over three years. This suggests that the French economy may be edging toward a recession, despite earlier hopes for a growth boost from the upcoming summer Olympics. In Germany, the Ifo Institute reported that business confidence fell to 87 from 88.6, the lowest reading since February, going against predictions of an improvement.
The unexpected decline in French business confidence has been partly attributed to political instability following recent parliamentary elections, which saw gains by far-right and left-wing parties. This has created uncertainty among business leaders, who are concerned about the lack of a stable government.
In Germany, the weakening confidence is linked to a combination of global economic uncertainties, geopolitical risks, and the ongoing effects of high inflation, which have dampened consumer spending and business investment.
Although the Eurozone economy managed modest growth earlier this year, recent signs suggest a deceleration. Economists are now cautious about the upcoming GDP figures, which are expected to confirm this slowdown. On a slightly positive note, there has been an increase in short-term lending to businesses within the Eurozone, but this is not seen as a strong indicator of future investment or economic recovery.
China lowers lending rates to stimulate growth
China's central bank, the People's Bank of China (PBOC), has lowered key lending rates to try to boost the economy. The one-year loan prime rate (LPR), which is important for business loans, was cut by 0.1 percentage points to 3.35%. The five-year LPR, which affects mortgage rates, was also reduced by 0.1 percentage points to 3.85%. This marks the first time these rates have been lowered since last year.
Earlier, the PBOC had also reduced the reverse repo rate, a key short-term lending rate, by 0.1 percentage points to 1.7%. The reverse repo rate helps set short-term borrowing costs in the financial system. Additionally, the central bank lowered rates on short-term loans it provides to banks by the same amount. These actions are part of the PBOC's efforts to support the economy, which has been struggling with a slowdown.
China has been cutting lending rates frequently to combat issues like the ongoing slump in the property market and weak consumer spending. These challenges have led policymakers to take stronger actions to try to restore confidence in the economy.
Recent economic data highlights these struggles, with the economy growing by 4.7% in the second quarter, which was below expectations. The property sector, a major part of China's economy, is also in trouble, with new home prices falling 4.5% last month—the largest drop in nearly ten years.
The rate cuts were expected after a recent meeting of the Communist Party's Central Committee, where concerns about the economy were discussed and further support measures were promised. The government has also taken other steps, like allowing state-owned companies to buy unsold homes, but these have not yet had a big impact.
China's method of setting interest rates has changed over time, with the LPR now linked to a medium-term lending facility that influences the availability of money in the banking system. The central bank's governor, Pan Gongsheng, suggested that the repo rate might become more important in future decisions.
Following the rate cuts, China's 10-year government bond yield fell to 2.24%, and the renminbi weakened to its lowest level in nearly two weeks against the U.S. dollar, reflecting ongoing concerns about whether these measures will be enough to solve the country’s economic challenges.