© Reuters. Federal Reserve Board building on Constitution Avenue is pictured in Washington
1/FED IN A HOLE
On Wednesday, the U.S. Federal Reserve releases the minutes of its last meeting, revealing what policymakers said about the flattening Treasury yield curve and the strength of support for July’s quarter-point rate cut.
But given what has transpired in bond and stock markets since that meeting, the more relevant headlines should spring from the Fed’s annual Jackson Hole Symposium later in the week, with Chairman Jerome Powell to address the forum on Friday.
Now that the long-awaited inversion of the two-year/10-year yield curve has actually happened, there is some question whether the Fed will lean harder on the easing side to re-steepen the curve and quash recessionary interpretations.
The Fed looks boxed in. Wall Street has had a torrid few days, having lost more than 4% this month. All Treasury maturities now yield less than 2% for the first time ever.
Then add in President Donald Trump’s tweets about “clueless” Powell and the “crazy” inverted yield curve even as Washington’s trade wars dent business confidence.
Meanwhile, strong July retail sales and gangbuster Walmart (NYSE:) earnings indicate the economy’s all-powerful consumer is undaunted. That argues against the Fed doing much more.
Still, futures traders see no chance the Fed will stand pat in September, with CME’s FedWatch tool showing about a 67% probability of a 25 basis-point cut and 33% odds for a 50-point cut.
By the end of the year, money markets are 78% positive that the target Fed funds range will be 50-75 basis points lower than the current 2.00-2.25%.
GRAPHIC: Yield curve inversions, recessions & U.S. stocks – https://fingfx.thomsonreuters.com/gfx/mkt/12/4756/4718/Pasted%20Image.jpg
If economists could take any consolation at all from the steadily worsening economic data worldwide, it was that the malaise has appeared confined to manufacturing.
Services, which comprise the bigger part of developed countries’ GDP, has held up pretty well. July numbers though were sobering — purchasing managers indexes (PMI), generally a good measure of overall economic health, hinted that factories’ sickness may be spreading.
So advance August PMI readings, due on Thursday, will draw scrutiny, especially with global bond markets flagging a looming economic downturn.
Take the United States. Manufacturing there slowed to a near 10-year low in July, to the neutral 50-mark on the PMI index yet services accelerated to 53, the IHS Markit data showed. But readings from the Institute for Supply Management suggested services were about to take a hit, with new orders hitting three-year lows.
In the euro zone, a dismal manufacturing print of 46.5 contrasted with services at a relatively robust 53.2. But services were down from June, while composite PMIs that combine both sectors slipped to three-month lows of 51.5.
Globally, manufacturing PMIs are deep in the red, with only services holding the composite print above the 50-mark.
If the upcoming ‘flash’ PMIs confirm that the manufacturing downturn is affecting the services industry, bond markets’ assessment of the economic outlook may be correct.
GRAPHIC: Global composite PMIs – https://fingfx.thomsonreuters.com/gfx/mkt/12/4803/4760/PMIs.png
Global bond market developments have of late overshadowed Italian political shenanigans, but that may soon change.
Prime Minister Giuseppe Conte addresses the Senate on Tuesday, after it frustrated Deputy Prime Minister Matteo Salvini’s attempt to pull the plug on his coalition with the 5-Star Movement and trigger snap elections.
Meanwhile 5-Star politicians themselves are discussing forming a coalition with the opposition Democratic Party.
The prospect of election uncertainty had sent Italy’s 10-year bond yield premium above Germany to 239 basis points a week back.
It’s retreated since then to around 200 bps. But if President Sergio Mattarella decides there’s no way of creating a stable government, early elections will be called, probably for late October.
GRAPHIC: Italy’s 10-year bond yield gap over Germany – https://fingfx.thomsonreuters.com/gfx/mkt/12/4804/4761/ITtheme1509.png
As if Japan’s economy didn’t already have enough headwinds, a rising yen has joined the mix.
The past week’s gyrations in U.S. Treasuries, including a short-lived inversion that whipped up recession fears, plus weaker stock markets, rising volatility and more Trump capriciousness on the trade war with China have sent investors scurrying into the safe havens of gold and the yen.
While Japan’s growth has been picking up ever so slightly, the headwinds from an upcoming sales tax hike, trade tensions with neighbor South Korea and the threat of U.S. tariffs on its auto exports are set to keep consumption and trade weak in the second half of the year.
Next week’s trade data is expected to show exports fell for the eighth month in July, while a Reuters manufacturing sentiment index should reflect rising concerns.
Meanwhile, the Bank of Japan appears helpless as a worldwide decline in bond yields drags its 10-year yield to below the minus 0.2% floor it has set as part of its yield curve control policy, and as the yen rises 3% in a matter of days.
If it really wants to cap the rising yen and put a floor under yields, it needs to stop buying the bonds it mops up as part of its quantitative easing policy. But that would erode its credibility and backfire on the economy.
GRAPHIC: A rising yen is another headwind for Japan – https://fingfx.thomsonreuters.com/gfx/mkt/12/4838/4795/Pasted%20Image.jpg
Investors have been fretting that the U.S. inverted bond yield curve is pointing to a U.S. recession in the next couple of years, but warning signs pointing to more immediate trouble have been flashing this week elsewhere in the world.
In China, industrial output hit a more than 17-year low in July, highlighting again the damage from the protracted U.S.-China trade dispute.
Europe Inc is suffering from recession, with profits in the three months to the end of June expected to fall for a second consecutive quarter, while data showed Germany’s economy went into reverse in the second quarter, reinforcing worries about the region’s macro and corporate health.
In another sign of deepening stress in the bloc, stocks in the big banks plunged on Thursday to their lowest since 2012 at the peak of the euro zone debt crisis.
They are now on the brink of hitting their lowest since the 1980s as negative rates, stiff regulation and rising costs take their toll.
With bond yields showing no signs of staging a major recovery any time soon, investors will likely remain cautious on the battered banking sector.
GRAPHIC: Euro zone bank share meltdown brings prices to brink of 1980s – https://fingfx.thomsonreuters.com/gfx/buzzifr/14/4040/4040/Pasted%20Image.jpg