Global Expansion, Central Bank Strategy, the Bond Market and the Dollar

The global expansion remains engaged. The U.S economy, representing about one-fifth of global demand, got off to a sluggish start with 1.4 percent real GDP growth (annualized) in the first quarter. We expect U.S. GDP growth to approximately double for the recently completed second quarter. The Bureau of Economic Analysis will release the first estimate of Q2 GDP on July 28. Europe collectively represents a little more than a fifth of global demand and continues to show positive data with several countries growing faster than the United States. China, also representing about a fifth of global GDP, has recently looked a little better after a softer start to the year. Japan is gaining momentum. Together, these four regions represent about three-quarters of the global economy, and all of them are generating more demand.

A key theme for many central banks this year and next is to take advantage of the synchronized global expansion and begin normalizing monetary policy. This means raising interest rates off of the near zero, or below zero, floor. It also means gradually winding down extraordinary policy such as asset purchase programs, otherwise known as quantitative easing (QE). Finally, it means renormalizing the vastly expanded balance sheets that came as a result of QE.

The U.S. Federal Reserve took the lead amongst major central banks in driving interest rates down to near zero by the end of 2008. It took a leading role in central bank asset purchases, beginning QE1 in December 2008. It is also taking the lead in winding down extraordinary policy. The Fed ended asset purchases with the termination of QE3 in December 2013. It began lifting interest rates in late 2015, and has managed four 25-basis-point increases in the benchmark fed funds rate since then. The Fed has also announced its intention to begin reducing the size of its vastly expanded balance sheet, possibly as early as this October.

Recently, other central banks have begun to hint that they may also start to normalize policy. European Central Bank President Mario Draghi recently made bullish comments about the European economy that suggest he may announce the winding down of the ECB’s asset purchase program by the end of this year, to commence sometime in 2018. The euro climbed against the dollar after Draghi’s comments. U.S Treasury bond yields increased as expectations for future demand eased.

Bank of England President Mark Carney’s recent comments suggest that he may be considering an increase in the BOE’s benchmark interest rate soon. The Bank of England will be an interesting case because their economic tailwind may be fading. The UK has enjoyed one of the fastest growing economies in Europe recently, but that changed in 2017Q1 when UK real GDP growth slowed to 0.2 percent (quarter-to-quarter). This was the slowest 2017Q1 GDP growth of all the G7 countries. Canada was the fastest.

Confirmation of policy normalization by the ECB and other central banks will put more downward pressure on the dollar and upward pressure on Treasury bond yields. Downward movement on the value of the dollar would be good news for U.S. exporters, lowering their prices in local currencies. A weaker dollar would also revive import price inflation, giving the Fed a little more justification for its normalization policy. Finally, a weaker dollar would be welcome news for U.S. border regions that have seen trade with Mexico and Canada decline.

For a PDF version of the complete Comerica U.S. Monthly with additional commentary, tables, and charts, click here:  US_Economic_Outlook_0717.


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