Political transition, VW emissions, and the Fed add uncertainty to markets

Politics and policy remained front and center for markets last week. The news that Volkswagen (VW) had “cheated” on U.S. emissions tests for its diesel engines reduced market confidence as we also waited for Federal Reserve Chair Janet Yellen to clarify confounding Federal Open Market Committee (FOMC) meeting comments from Sept. 17.

Just as the market had priced in VW uncertainty and some belief that Janet Yellen would like to raise U.S. interest rates at the December FOMC meeting, House Speaker John Boehner announced he would step down on Oct. 30. While this may make a short-term budget deal easier, it creates some uncertainty for year-end. A temporary budget deal may now expire in mid-December, which is about the same time as when we might hit the U.S. debt ceiling. These policy uncertainties typically leave market participants feeling like risks are higher.

In September, the “flash” reading of the manufacturing Purchasing Managers’ Index (PMI) softened, with China contracting and the index hitting a 78-month low, which reflected slower growth in Europe, Japan, and the United States. U.S. durable goods orders fell 2% for August and were flat, excluding the volatile transportation sector, which confirmed some of the weakness in the PMI data. Japan rolled back into deflation, with Tokyo consumer prices for September declining 0.1% for the past year and national core prices, excluding perishables, falling 0.1% for the year ending in August.

On the positive side of the ledger, the University of Michigan Consumer Sentiment Index improved slightly from the midmonth estimate to 87.2, although this is the lowest final reading so far in 2015. Additionally, second quarter U.S. gross domestic product (GDP) was revised higher by 0.2 points, to 3.9%, because of stronger consumer spending. In general, policy and data are combining to indicate there is risk to growth in the last part of 2015 due to policy uncertainty and softer manufacturing activity.

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While U.S. growth is unlikely to match the 3.9% second quarter rate in the second half of 2015, we believe the economy should still grow around 2.5% for the year, supported by a solid consumer base. This week’s U.S. employment report will be an important indicator of the likely health of the U.S. consumer and some indication whether U.S. data still support Fed lift-off this year.

Outside of the United States, additional policy accommodation is likely to rekindle growth, particularly in Japan. In China, growth is likely to continue to slow but remain positive, with the activity rebalancing from investments and exports toward services and consumption.

For more information, please go to: https://reserve.usbank.com/insights/market-economic-update.

Robert L. Haworth, CFA, is a senior investment strategist and Darrell Behnke is the Madison market leader for the Private Client Reserve of U.S. Bank.

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