The New Year began with an extension of December’s mayhem, but the downtrend finally met worthwhile resistance as a confluence of factors propped up sagging risk sentiment. It started with China’s RRR cut – part liquidity adjustment ahead of the Chinese New Year and part easing rates in response to further signs of a coming economic slowdown – and was followed by a bumper nonfarm payrolls report confirming that US growth momentum still has legs.
The clincher came from Federal Reserve chair Jerome Powell, who left no scope for ambiguity when he said that the Fed is listening to the mood of the markets and is committed to policy flexibility. The two rate hikes for 2019, priced in by markets as recently as September, consequently appear impossible. Equities were happy to finally see some evidence for ‘the Powell put’ and rode the high to post a decent recovery from their Boxing Day lows.
It is an interesting thought experiment to wonder what the market’s reaction to the bumper NFP print would have been had the release not been followed by the dovish comments from Powell. By all measures, it was a rock-solid print. The headline number was a whopping 301,000 (versus a 161,000 consensus) and the past two months’ revisions came in at +58,000. Average hourly earnings ticked up to 0.4% and 3.2% annualised and that brought more participation (63.1%, the best since 2014) in the labour market, resulting in a higher unemployment rate at 3.9%.
Such strong data certainly reduce the odds of recession, but simultaneously build a strong case for the Fed to march along on its dot plots this year, especially if we see a consistent uptick in earnings growth.
Powell’s dovish tilt has acquired greater significance as it came after the data were published. The Fed chair still sent out his dovish message, closing his speech with a decisive hint as to the Fed’s flexibility on policy (both rates and balance sheet) and its intention to listen to markets.
Hints of a Fed pause and a strong US data print are perhaps the only factors that could have triggered a recovery in an increasingly gloomy market, and that is precisely what the markets received.
But how sustainable is this sweet spot?
Given that Powell has backtracked on his “we may go past neutral” comment from October, as well as his “we have balance sheet runoff on autopilot” comment in December so decisively, the Fed reverting to two hikes this year is unlikely to happen even with further strong jobs data. But with the market already pricing in practically no hikes in 2019 – the odds of a cut in December 2019 stand at 24.5% right now – there could still be a gap between the market’s interpretation of a dovish Fed and Powell’s idea of quickly altering policy in reaction to markets.
While I acknowledge a compelling case for USD weakness on this premise, I would take all the high-conviction short USD trade recommendations floating since Friday with a pinch of salt until further cues of a definitive, year-long pause emerges from the Fed and Powell.
On equities, the current optimism is reasonable given the scale of markets’ correction in December (with the SPX even entering bear territory for a brief while on December 26) and US stocks tactically remain a good long option for further gains. While a Fed pause and progress on US-China trade talks might provide much-needed support to the markets, the fundamentals of a late-cycle slowdown in US as fiscal stimulus fades is a stark reality facing the markets in 2020 and 2021, if not later this year.
With China unlikely to make a V-shaped recovery from its slowdown even with further monetary easing, and a possibly compromised trade deal with US, the gestation period of China-driven global growth recovery is still quite long. There is also the evidence of rising wages at home in US coinciding with a broad-based slowdown in US to consider; in our view, Apple’s slashing of revenue guidance is merely the start of the margin squeeze cycle for US firms and not the end.