BoE Policy Outlook: Upside Risks Are Diminishing

The Bank of England (BoE) will be on hold in the near term given its uncertainty about the economic outlook.
The Minutes from the latest BoE meeting highlight the conflicting signals emanating from the U.K. economy. The CBI index of manufacturers’ expectations has rebounded sharply this year, aided by a strong global economy. However, the consumer picture is mixed, with some recovery underway in retail activity, while some leading indicators of housing turning down. Moreover, the turbulence in financial markets in recent weeks argues for caution in the near term since core inflation is low and the U.K. is so heavily reliant on the financial sector and global demand. Bottom line: markets are discounting 30 bps of rate hikes in the next six months, but the risks are building against that outcome as global growth decelerates.

U.S. Leading Economic Indicator: Slowdown Ahead

The Conference Board’s Leading Economic Indicator (LEI) declined again in May, with downward revisions in previous months, and now hangs precariously close to its boom/bust line.

The U.S. LEI should only be used as a directional indicator and its message is to expect some moderation in growth (it gave a prematurely strong signal in 2002 and has been much soggier than the economy in the past year or two). The financial markets have recently confirmed the downbeat message: the stock-to-bond ratio has declined, which is also consistent with a weaker economy. Consumption growth will be the weak link, as interest burdens mount at a time when housing wealth is slowing. Indeed, consumer related areas have been responsible for most of the recent weakness in the LEI. Bottom line: the economic risks will remain on the downside at least until the Fed stops tightening.

Are Bearish Investors A Contrarian Signal For U.S. Equities?

Bearish investor sentiment suggests U.S. equities could bounce in the near term.

The Investors’ Intelligence net bullish sentiment reading has fallen to a three-year low as the S&P 500 has corrected. This sentiment gauge has been a fairly reliable contrarian indicator—stocks typically rally when sentiment declines rapidly or reaches extreme lows. The implication is that stocks are due for a rebound. However, the macroeconomic backdrop poses a hurdle for more persistent gains. Equities rebounded strongly when sentiment hit similar lows in 1998, 2001 and 2003, but monetary policy support was critical in each case. Bottom line: conditions are lining up for further short-term gains, but (again) the U.S. stock market will need relief from the Fed to sustain an advance.

Prometheus from sources: ADM, Barclays Capital, Cazenove, Charles Stanley, HSBC, ING, SocGen, UBS.