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Week in Review: Fed Lays Groundwork for Summer Rate Hike

For the week ended 20 May 2016

  • FOMC minutes: Most participants said June rate hike would be appropriate if US economy continues to improve
  • US consumer prices, industrial production strengthened in April
  • Japan Q1 GDP grew faster than forecast, with caveats
  • IMF proposes Greek debt relief plan
  • US Treasury and House Republicans strike tentative deal to ease Puerto Rico debt crisis

Global equities were nearly unchanged on the week as the market grappled with the possibility of a rate hike from the US Federal Reserve in the coming months. The Chicago Board Options Exchange Volatility Index (VIX) rose to 16.08 from 14.23 a week ago, while the yield on the 10-year US Treasury note increased to 1.86% from 1.75%. West Texas Intermediate crude prices rose to $48.30 from $46.31 last week, and global Brent crude prices rose to $48.96 from $47.65.

GLOBAL ECONOMIC NEWS

Fed signals summer rate hike may be on tap
Minutes of the April Federal Open Market Committee meeting make clear that the US Federal Reserve would like to raise rates at either its June or July meeting, if conditions allow. Most FOMC members said a June rate hike would be appropriate if the economy continues to improve. Risks to that outlook include a UK referendum on whether to leave the European Union on 23 June and possible instability associated with China's currency, according to the minutes.

Q2 US growth looks stronger
While the April US employment report was slightly weaker than forecast two weeks ago, several recent data points show an uptick in both economic activity and inflation. US industrial production rose a robust 0.7% in April, led by utilities output, while the Consumer Price Index rose 0.4%, the strongest monthly reading in more than three years. Housing starts rose at a stronger-than-expected rate of 6.6% in April, while building permits rose 3.6% from the previous month. The recent data dovetails with more hawkish rhetoric from the Fed.

Look before you leap (year)
Japan reported a robust 1.7% annualized rate of growth in gross domestic product in the first quarter of the year. However, looks can be deceiving as Japan is one of the few nations that does not seasonally adjust its GDP data for leap years. The extra day gained is believed to have accounted for about 1% of the 1.7% growth rate. Capital expenditures continue to contract in Japan despite record-low interest rates resulting from the Bank of Japan's negative interest rate policy.

Greek debt-relief plan floated
The International Monetary Fund proposed a debt relief package for Greece in advance of a European summit to tackle Greek finances on 24 May. The IMF proposal includes provisions that payments of principal and interest would be skipped until 2040 and some loans would extend their maturities out to 2080. Germany is said to see the IMF proposal as an opening bid in a negotiation that EU leaders would like to conclude next week. The hope is for a quick agreement on a debt deal so as to avoid a messy intra-EU battle in the run up to the 23 June Brexit referendum.

Tentative deal to assuage Puerto Rico debt crisis reached
The US Department of the Treasury and Republicans in the US of Representatives House have reached a tentative deal to set up a financial control board to take charge of Puerto Rico's debt crisis. The board would manage financial obligations and oversee some debt restructuring. No US federal funds are being committed as part of the package.

Saudi credit rating cut by Moody's
Moody's Investors Service cut its rating on Saudi Arabia's debt to A1 from Aa3, citing a combination of lower growth, higher debt levels and smaller domestic and external buffers, which have weakened the Kingdom's ability to weather future shocks. However, recently announced economic reforms could lead to a higher rating over time, the agency said.

China data underwhelm
China reported somewhat weaker than expected economic data this week. Industrial production, retail sales and fixed asset investment were all below economists' forecasts. China's highly indebted economy continues to struggle amid slowing growth as it transitions from an investment-driven to a consumer-led economy.

ECB takes it to the limit
The European Central Bank's bond buying program is beginning to run up against purchase caps in government bonds issued by some of its member countries. The ECB has a self-imposed limit of one-third of a country's outstanding debt. With nearly a year to go in the program, the central bank has almost reached its limits because of purchases of Irish and Portuguese government bonds during the debt crisis earlier this decade.

Philippines dislodges China as Asia's fastest-growing economy
Economic growth in the Philippines expanded at 6.9% in Q1, the fastest pace in that country since the 1970s. China's growth slipped to a 6.7% annual rate in the same quarter. Economists cited strong growing domestic demand in the Philippines, spurred by infrastructure spending and consumption.

Egyptian navy recovers first debris in wake of plane crash
A Cairo-bound flight from Paris crashed into the Mediterranean Sea just inside Egyptian airspace. While a forensic examination of the wreckage has not yet begun, the working assumption of Egyptian authorities is that the flight was brought down by an act of terrorism.

GLOBAL CORPORATE NEWS

ChemChina–Syngenta deal receives US scrutiny
A proposed $43 billion purchase of Syngenta by ChemChina has been delayed by additional scrutiny from the US Treasury Department's Committee on Foreign Investment in the United States (CFIUS) and the US Department of Agriculture. The delay has prompted ChemChina to extend its offer period until July, pending the results of the regulatory review.

Bayer makes unsolicited bid for Monsanto
In another agricultural deal, Germany's Bayer has made a bid for seed and pesticide maker Monsanto. The deal would create the world's largest seed and pesticide company and is valued at $42 billion.

Oil services companies plan merger
FMC Technologies announced a planned merger with France's Technip in a $13 billion transaction. The deal will build on an existing joint venture between the US and French firms, with the combined company to be headquartered in London.

THE WEEK AHEAD

  • A meeting of G7 finance ministers and central bankers concludes Saturday, 21 May in Japan
  • Japan releases trade data on Monday, 23 May
  • Flash purchasing managers' indices are released globally on Monday, 23 May
  • Germany's Ifo releases its business climate survey on Wednesday, 25 May
  • Q1 UK gross domestic product is reported on Wednesday, 25 May
  • Revised Q1 US GDP data are released on Friday, 27 May

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Sources: MFS research; The Wall Street Journal; The Wall Street Journal Online; Bloomberg News; Financial Times; Forbes.com; CNNMoney.com; NBCNews.com.

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