Highlights

The Federal Reserve is expected to raise rates in 3Q11
BBVA Research has pushed back its baseline forecast for the first fed funds rate hike to 3Q11 from 1Q11. Recent economic trends indicate that substantial economic slack remains and the pace of growth is going to ease in the second half of the year. The employment situation could remain a drag on economic growth and is likely to play a large role in Fed policy decisions. While the labor market is improving, the tempo is not sufficient to result in a marked improvement in the unemployment rate. Furthermore, new risks have emerged due to the EU’s sovereign debt problems, which have added substantial uncertainty to the financial markets and economic outlook. In addition, inflation expectations are well anchored and core inflation is expected to remain subdued through 2012. Given the more uncertain outlook and low risk of inflation, the Fed will maintain low rates for a prolonged period. In addition, if downside risks increase further, the Fed could re-start quantitative easing measures in order to assure financial stability.

Housing demand will pick up slowly throughout the year but construction will remain weak
Residential construction activity has slowed since the end of the home buyers’ tax credit due to uncertainty surrounding the future pace of demand. This is illustrated by the decline in housing starts to 549K in June from 578K in May. After posting positive year-over-year growth for the past six months, the year-over-year rate dropped to -5.8%. On the demand side, existing home sales dropped to a 5.37M annual rate in June from 5.66M. The decline was anticipated given less foot traffic following the expiration of the home buyers’ tax credit, but sales did exceed consensus expectations of 5.26M. Housing demand is expected to remain low in the near-term due to the post-tax credit adjustment, but it will firm slowly throughout the year. The large supply of existing homes on the market will keep prices low and favorable to buyers. However, this supply will also hinder new construction as the market is already over-saturated with available homes. As a result, residential investment is expected to remain weak.


Week Ahead


New Home Sales (June, Monday 10:00 ET)

Forecast: 319K Consensus: 312K Previous: 300K

New home sales are expected to remain weak in June due to the slowdown in demand following the expiration of the home buyers’ tax credit. However, there are also challenges unique to this market compared to that of existing homes. First, the supply of new homes is extremely low and is competing again the excess supply of existing homes. In addition, the low prices of existing homes make them more competitive than new homes. As a result, buyers are more likely to buy an existing home. Sales of new and existing homes will continue to move in unique directions because the existing homes market has the advantages of supply and price over that of new homes.


Consumer Confidence (July, Tuesday 10:00 ET)

Forecast: 52.6 Consensus: 51.0 Previous: 52.9

Consumer confidence is expected to drop in July and remain close to the average that it has maintained for over a year. Even though the employment situation has begun to improve, households remain concerned about its slow pace of recovery. A slowdown in consumer confidence would support our expectation that the pace of growth of consumer spending will slow in the second half of the year. Consumer confidence will not change course until there is a faster pace of hiring and more certainty in the economic outlook.


Durable Goods Orders (June, Wednesday 8:30 ET)

Forecast: 0.9% Consensus: 1.0% Previous: -1.1%

Orders for durable goods are expected to rise in June. In contrast to the previous month, transportation orders will boost the overall figure. Excluding transportation orders will continue to rise but at slower pace, indicating that business demand remains firm. This report is volatile on a monthly basis, but the year-over-year rate is expected to remain at historically high levels, highlighting the strength of the recovery. An increase in new orders would indicate that industrial production will continue to strengthen in July.


Real GDP (q/q annualized) (Preliminary 2Q10, Friday 8:30 ET)

Forecast: 3.2% Consensus: 2.5% Previous: 2.7%

The economy is expected to expand at a faster pace in the second quarter than in the first. Fiscal stimulus and inventories continue to support economic growth, but private demand is taking hold as well. Business investment in equipment and software strengthened in 2Q10, but consumer spending grew at a slower rate. A negative surprise in second quarter growth would indicate significant weakness in the economy and increase the debate about the necessity of additional fiscal stimulus.


Market Impact

All eyes will be on Friday’s 2Q10 preliminary GDP results. Market expectations have taken a negative turn in recent weeks and worse than expected results would add fuel to the fire. We expect economic growth to continue in 2H10, but at a slower pace than in the first half. A negative surprise in the GDP figures could indicate that average GDP growth in 2010 could come in below our forecast of 3.0%