ECB leaves European markets stranded, but for how long? The European Central Bank’s decision to keep its key interest rate at 0.75% was a blow to equity markets this past week. However, with the Eurozone seemingly headed for further GDP contraction in the third quarter and with inflationary pressures muted, we expect the ECB to trim interest rates from 0.75% to 0.50%. Following ECB president Mario Draghi’s speech in London in late July, when he stated that the ECB “will do whatever it takes to preserve the euro,” the bank was under serious pressure to reveal strong policy measures or risk sparking major disappointment in the markets. Draghi indicated that the ECB will buy Eurozone bonds, but this will be dependent on the stressed countries going to the Eurozone stability funds first, with the conditionality that this involves. It also will not start before September, as “in the coming weeks, we will design the appropriate modalities for such policy measures.” There are some important steps forward here by the ECB, but after Draghi’s recent comments about the ECB “doing whatever it takes” to preserve the Eurozone, markets were looking for more.

Favorable jobs report will not necessarily change the Fed outlook. As we expected, the Federal Reserve left interest-rate and balance-sheet policies unchanged. They admitted that the economy “decelerated” from earlier in the year, but presumably some Fed members were still not convinced that further easing was warranted and wanted to see another couple of jobs reports before making a decision. They now have one. The unemployment rate rounded up to 8.3% in July, but payroll growth of 163,000 blew past expectations of 90,000. The report will alleviate fears that the United States might be tipping back into recession, but we do not believe that it was strong enough to dissuade the Fed from introducing a new quantitative easing program (QE3) at its next meeting (September 13). It does, however, raise the importance of the next employment report (due September 7). If it is better again than this month's report, the Fed might decide to wait until December to consider further action. But we do not think job growth will be strong enough to change Fed members’ minds, and our baseline case remains QE3 in September.

No recession signals in other data. The ISM Manufacturing Index indicated mild contraction in the manufacturing sector during July. But the ISM Non-Manufacturing Index moved a bit higher last month thanks to gains in activity and orders. The main negative in this report was the employment component, which slipped below the neutral-50 mark. But this was at odds with the July employment report, which showed substantial payroll gains in some key non-manufacturing industries. So, the non-manufacturing index may even be a bit healthier than it looks. The composite ISM Manufacturing/Non-Manufacturing Index moved up to 52.3, signaling ongoing growth. But the index is still down more than four points from the high-water mark of 56.7 reached in February, suggesting that growth will stay soft. Our third-quarter real GDP growth estimate stands in the 1.0–1.5% range, down from 2.0% in the first quarter.

Wednesday, August 8 – Productivity (Preliminary Q2)

Nonfarm Business Productivity

• IHS Global Insight: 1.1%
• Consensus: 1.4%
• Last Actual: -0.9% (Q1)

Unit Labor Costs

• IHS Global Insight: 1.7%
• Consensus: 0.4%
• Last Actual: 1.3% (Q1)

What to Look For

• Rebound to productivity growth

Implications

Labor productivity growth is seen rebounding to 1.1% in the second quarter, after a 0.9% contraction in the first. Output growth likely slowed a bit to 2.0%, but labor hours growth was probably an anemic 0.9%. Meanwhile, unit labor costs likely increased 1.7% due to a 2.8% gain in hourly compensation.

Thursday, August 9 – Trade Balance (Jun.)

• IHS Global Insight: -$47.6 Billion
• Consensus: -$47.6 Billion
• Last Actual: -$48.7 Billion (May)

What to Look For

• A narrower deficit, fueled by minor increase in exports and decline in oil imports

Implications

The trade deficit is expected to have narrowed by $1.1 billion to -$47.6 billion in June. The oil import bill likely shrank again thanks to a collapse in prices. Exports were probably boosted slightly by a rebound in automotive goods and industrial supplies.