Enjoy the Quiet Before the Storm
Summary: Equities ended the week on a positive note, with the SP500 hovering a stones throw from record highs supported by continued thawing in trade tensions. The sustainability of the present risk-on sentiment and compression of volatility, induced by easing trade tensions and re pricing of no-deal Brexit risks, will be tested this week as event risk climaxes. The biggest tail risks facing the global economy have moderated but the complacent calm of the status quo which defies economic realities has no shortage of opportunity for upset, and should sentiment prove to be more fragile than the present calm is dictating, volatility could come back with a bang this week.
The week ahead is jam packed with event risk as we highlighted last week, including:
- FOMC and BoJ meetings
- US ISM Manufacturing, GDP and Non-Farm Payrolls
- Australia Q3 CPI and building approvals
- EZ Q3 GDP and unemployment
- South Korea Exports and China Manufacturing PMIs
- China’s 4th plenum, Brexit circus
As the week begins price action across Asian equities and FX is subdued but risk sentiment continues to be supported by ongoing hopes of a "Phase 1" US/China trade deal being formally ratified at the APEC summit on 16-17th November. Over the weekend positive musings from China’s Ministry of Commerce confirmed trade negotiators “agreed to properly resolve their core concerns and confirmed that the technical consultations of some of the text agreement were basically completed,”, which is keeping sentiment buoyant and expectations high that China are ready to formalise the current truce and ink a mini-deal. US Vice President Pence’s speech last week claimed that Washington is not seeking confrontation with China or a decoupling from China, has also played into the hope that the US is also unwilling to dent any chance of formalising the present détente. But no matter what was touted in the speech the two superpowers are set on a long and winding path to decouple, as we have discussed previously.
This week’s FOMC meeting will take centre stage as the Fed deliver another 25bps rate cut, the market is pricing more than 90% odds of a rate cut and historically the Fed have always reduced rates against such heavy expectations. For markets the more pertinent question will be how much more will the Fed ease from here, if at all. The Fed will be meeting the threshold of what has historically been thought of as a mid-cycle adjustment (75bps) when they cut interest rates this week for a third time. In 1995 and 1998 when the Fed have previously delivered insurance cuts as part of a mid-cycle adjustment, three 25bps rate cuts sealed the deal. But as incoming data continues to show that the current synchronised global slowdown has persisted into Q4 and leading indicators still deteriorating the Fed will find it hard to deliver a hawkish cut and signal the end of insurance cuts. Growth is still trending lower and incoming data continues to confirm that a bottom has not yet been reached. At present we are not amid a mid-cycle slowdown, the economic expansion is long in the tooth and the question is whether the Fed can engineer a soft landing. Risks remain tilted to the downside for both US growth and global growth. And whilst the Fed are reluctant to face this reality and remain behind the curve on the present growth slowdown, supporting liquidity with NOT QE asset purchases then the efficacy of these policies is reduced. However, the Fed are unlikely to communicate this and box themselves into a corner on continuing to cut rates. Instead it is more likely Powell communicates their data dependence and willingness to sustain the current expansion meaning markets will be highly sensitive to the incoming data in November.
To that note Friday’s payroll report and ISM Manufacturing read will be hugely important. To date momentum has clearly slowed in the US labour market, which is also one of the most lagging indicators of economic health, consistent with the underlying weakness in the economy evidenced by suppressed capex intentions, faltering business confidence and a manufacturing sector under pressure. August payroll gains were weak and previous months were revised lower highlighting a cooling pace in hiring from monthly job gains of 223,000 in 2018 to 158,000 this year. Another broad indicator of underlying labour market weakness, underemployment, picked up in August indicating slack in the jobs market might be on the rise. If underemployment continues to rise in coming months, this would herald an incoming loosening of the labour market and continued deceleration in economic conditions.
Leading indicators have continued to point to an ongoing slowdown in the labour market and if this comes to fruition it will be much harder for the consumer to maintain the level of spending needed to support the US economy whilst the manufacturing sector continues to deteriorate. Particularly if recessionary dynamics in the manufacturing sector seep into the services sector where the bulk of employment sits.
Also, towards the end of the week China manufacturing PMIs and South Korean export data will be closely watched. South Korean exports for the first 20 days of October posted a 20% decline from a year earlier so it looks like exports will contract for the 11th consecutive month once the month is out. South Korean data is typically a bellwether for global trade, giving a good read on the health of the global economy and global demand given that its industries are heavily integrated within the global supply chain and highly cyclical. Continued contraction in exports tempers any optimistic notion of a recovery in tech demand and global demand being around the corner.
Over the weekend China industrial profits tumbled the most in four years as the tariffs and hangover from the deleveraging drive take their toll on economic activity. Earnings across all state-owned manufacturing sectors fell, despite government stimulus efforts, corroborating the contraction in PPI earlier this month. This comes off the back of the 3Q GDP report that showed economic growth narrowly avoided falling below 6%. Stimulus measures are yet to engender a bottom in economic activity in China, indicative of the fact that not only are transmission mechanisms stunted and the trade war weighing on economic activity. But China are reasonably comfortable with slowing trend growth and are not implementing a huge credit fuelled stimulus package as was seen in 08/09, 15/16. Stabilisation is a priority and there is 0 tolerance for a collapse in growth, but targeted stimulus measures and the absence of a huge reflationary package indicate policy makers are tolerant of slower growth rates. Chinese policymakers are also focusing on quality over quantity in terms of economic growth and grappling with switching from an export-driven economy to a consumption/ domestic demand-led economic growth model. Stimulus measures are likely to remain supportive in order to bolster economic growth and are unlikely to be wound back until later this year when the recovery is less fragile. But by the same token, unless we see the economic slowdown deepen again, a large-scale stimulus is not on the cards for the remainder of 2019.
China manufacturing PMIs are likely to show that the trade war continues to weigh and without a rollback of tariffs Chinese industry continues to suffer. Activity levels remain precarious and the economy is not out the woods yet regardless of the current trade détente.
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