Bank of the West US Outlook Report for August 12, 2016

The economic indicators out of the Eurozone and emerging markets have come in somewhat better than expected over the past few weeks. Generally, global economic surprise indexes have turned more positive, excluding data out of the United Kingdom.   Eurozone Q2 GDP increased 0.3%, in-line with economist expectations, and Eurozone industrial production increased a better than expected 0.6% in June.

Global manufacturing purchasing manager indexes (PMIs) improved in July, according to Markit, especially for emerging markets.  Importantly, composite PMI’s that encompass both manufacturing  and service businesses point to a pick-up in activity in India and China compared to a year ago.

The OECD’s global composite leading indicators have also been slowly improving since last August, pointing to the fact that stabilization of the global economy may have started gathering pace late last year.

At the same time, readings of financial stress have continued to improve since the knee-jerk post-Brexit vote tightening. A financial stress indicator complied by the St. Louis Fed is at its lowest level since last summer. This indicator compiles 18 weekly indicators of financial stress: 7 interest rate series, 6 yield spread indicators, and 5 other indicators of financial stress. A reading of zero on this measure represents a period of normal financial stress, so the current reading of -1.1 implies a relatively low level of financial stress remains in place.

Other measures of Treasury bond and stock market volatility are well below average levels as well. A measure of bond option volatility is the lowest since December 2014.  The Chicago Board Option Exchange VIX index, a measure of S&P 500 volatility, recently slipped below 12 compared to an average level of 17.96 over the past 12 months. The lack of financial stress in the global economy means the shock from Brexit may largely be limited to the United Kingdom and some of its major trading partners.

Finally, steady job growth and healthy real consumption expenditures in the United States will help the global economy, but looser economic policies abroad may also start to have a positive effect on the global outlook. Downside risks to the global economy from Brexit continue to diminish and a goldilocks scenario is gaining some credibility near-term.