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Moody's Weekly Market Outlook Summary

Core Content

This document provides an overview of the credit markets and economic outlook for the week ahead, focusing on the United States, Europe, and Asia-Pacific. It highlights key trends in inflation, interest rates, credit spreads, corporate profits, and employment data, along with insights from Moody's analysts.

Main Points

1. Inflation and Interest Rate Risk

• The recent slowdown in underlying consumer price inflation has significantly reduced the risk of a disruptive rise in interest rates.
• The VIX index dropped from 16.0 in August 10, 2017, to 10.7, reflecting lower market volatility.
• High-yield bond spreads narrowed from 410 bp to 399 bp by August 30, 2017.
• However, the narrowing of spreads is limited by an increase in the average high-yield EDF (Expected Default Frequency) metric from 3.9% to 4.4%.
• Core PCE price index inflation in July was 1.4%, below the 2.5% forecasted by the Blue Chip consensus for Q3-2017.
• The FOMC has historically struggled to maintain PCE inflation at 2% or higher, with only 24.2% of the past 20 years showing at least 2% annual growth.

2. Personal Savings and Inflation

• A decline in personal savings rate (from 6.1% in 2015 to 3.8% in 2017) suggests households may not be able to absorb higher prices.
• In 1970-1981, when core PCE inflation was 6.4%, the savings rate was 11.7%, highlighting the link between savings and inflation tolerance.
• The drop in savings indicates a more fragile consumer spending environment, especially for households on a paycheck-to-paycheck basis.

3. Corporate Profits and Recession Risk

• Corporate profits from current production have shown improvement, with a 7.0% annual increase in pretax profits in Q2-2017.
• The relationship between corporate gross value added (GVA) and employment costs is critical to understanding profit trends.
• A faster growth of GVA relative to employment costs is essential for sustaining corporate profits.
• Corporate GVA growth has slowed from 5.9% in Q1-2011 to 1.8% in Q2-2017, but it has been more robust than the previous quarter.
• The document notes that each 1% increase in the GVA-employment cost gap leads to an 8% rise in operating profits.

4. Economic Outlook for the Week Ahead

• The U.S.

  • August Employment Report: Expected to show job growth of 163,000, weaker than July's 209,000 but above the threshold to keep up with population growth.
  • Jobless Claims: Forecast to rise to 238,000, aligning with the four-week moving average. Seasonal adjustments may have reduced job growth by 50,000 to 100,000 since 2010.
  • Consumer Confidence: Expected to rise from 121.1 to 124.1 in August, with services and utilities showing strong growth.
  • GDP Growth: The second-quarter GDP growth is expected to be revised up to 3% at an annual rate, with upward revisions in services and intellectual property spending.
  • ADP Employment Report: Private employment is forecast to rise by 178,000 from June to July, but the ADP estimate may underestimate the BLS data by 17,000.
  • ISM Manufacturing Index: Expected to rise from 56.3 to 57.2 in August, with manufacturing fundamentals improving due to a stronger global economy and a weaker U.S. dollar.
  • Vehicle Sales: Forecast to decline slightly to 16.6 million annualized units in August, as inventories rise and demand slows.

• Europe

  • The week will focus on retail sales and household spending data from Spain, Germany, and France, with the French consumer survey expected to show increased spending in July.
  • UK consumer sentiment is expected to remain weak due to uncertainty surrounding Brexit.
  • Household consumption in the UK cooled to 0.1% q/q in Q2-2017, with no signs of improvement in forward-looking indicators.
  • The UK's exit decision has dampened consumer confidence, leading to postponed big-ticket purchases.

Key Information

• Credit Spreads:
  • Investment Grade: Expected to exceed 115 bp by year-end 2017.
  • High Yield: May reach 450 bp by year-end 2017.
• Defaults:
  • US HY default rate is forecast to average 2.9% in Q2-2018, down from 3.6% in July 2017.
• Bond Issuance:
  • US$-denominated IG bond issuance reached a new high of $1.528 trillion in 2017.
  • US$-priced high-yield bond issuance is expected to rise to $425 billion, still below the 2014 peak of $435 billion.
• Moody's Contributors:
  • John Lonski, Njundu Sanneh, Franklin Kim, Yuki Choi, Tomas Holinka, Barbara Teixeira Araujo, and Katrina Ell are the key contributors to this report.
• Additional Resources:
  • The document links to Moody's recent publications on various topics, including yields, Korea, jobless rate, spreads, and sov risk.
  • It also references Moody's Credit Outlook, a sister publication with detailed rating agency analysis.

Conclusion

The report emphasizes that low inflation is reducing interest rate risk, but it also highlights the potential downside of weak consumer savings and the challenges of sustaining corporate profits. While the U.S. labor market remains strong, the report cautions against overconfidence due to seasonal adjustments and potential employment surprises. In Europe, consumer sentiment and spending trends are closely watched, with the UK's economic outlook being particularly affected by Brexit uncertainty. Overall, the market outlook remains cautiously optimistic, with key economic indicators expected to provide further insights.