Positive reversals, negative reversals, and record outflows from U.S. equity and bank loan funds marked a volatile week where most major indices finished in correction territory. Weakening soft and hard data out of China and Europe continued to point to a slowdown in several overseas economies while trade, Brexit, EU budget standoffs (Italy/France) weighed on market sentiment. The market has shifted to a higher, yet more normalized, volatility floor while global growth, trade conflict resolution, and forward monetary policy come into focus.
- European flash PMIs show manufacturing and services output at expansionary levels but have decelerated to 4yr lows while export orders declined for a third consecutive month while data in Japan revealed strong output and new orders but a weakening export sector.
- China released weak retail sales of 8.1% (15yr low), low industrial production of 5.4% (10yr low) but a healthy fixed investment pace of 7.8%.
- Ultimately, China will be forced to pick up the pace of stimulus, as it becomes increasingly clear that the economy needs it. However, this is likely to be a story only for the second or third quarter of 2019, suggesting Chinese growth may continue to disappoint until then.
- Starkly contrasting regional perceptions of the U.S.-Sino trade conflict is a prominent risk factor behind the curtain. Tariffs are viewed as simple bargaining chips/tactics in the U.S. but are seen through a nationalistic and longer-term policy lens in China. China is closely monitoring and censoring all trade negotiation press made available in the mainland.
- Chinese concessions thus far include reduced auto tariffs (40% to 15%) for a three-month period, a pledge to increase U.S. agricultural/energy/industrial imports, and addressing IP theft.
- Is it yield curves, monetary policy, and slowing global growth or tweets from “tariff man” that are driving markets? Mentions of tariffs or trade have topped talk about FAANGS, the Fed, the bond market, jobs, the economy and inflation since late February.
- U.S. Treasury reports of tariff collections have grown from $3b/mo in February to $6b/mo in November. Historically tariffs have averaged 0.15% of GDP and 1.5% of total imports with current pace at 0.3% (2x) and 2.3% (1.5x) respectively. The tax rate on imports has risen sharply, but it’s still very small relative to, for example, sales taxes in most states.
- Bianco runs probabilities of a U.S. recession occurring in the next 12 months using a blend of economic data and U.S. Treasury curve spreads since 1962. The current forecast shows a low 5% probability of a recession occurring between now and November 2019.
- The spread between investor and Fed rate expectations is pushing higher risk asset volatility. Through year end 2019, BCA is forecasting five hikes (contrarian), a Bianco Fed speech model is implying 3.5 hikes, and markets are only pricing 40bps over the same period.
- The ECB noted risks of slowing growth but left rates unchanged with assurance to keep current levels through summer 2019. They will halt net QE purchases at the end this month as announced but said they will maintain reinvestment past the date of the first rate hike.
- U.S. inflation breakeven spreads have fallen in sympathy with oil prices but forward 3, 5, 7yr inflation expectations have fallen as well giving FOMC doves something to coo about.
- Brexit considerations and budget battles are dominating headlines in the Eurozone. France is now expanding its deficit more than Italy next year - they’ve run larger deficits than Italy every year since 2006 while Italy has run a primary surplus in all but 2 years since 1992.
Economic Release Highlights
- November YoY headline and core CPI both came in at 2.2%, viewed as a mixed-to-soft report which shouldn’t add much rate-hike pressure to next week’s FOMC meeting.
- November YoY retail sales of 4.2% largely beat expectations but was restrained due to a fall in gasoline prices and a big YoY hurdle rate. Ultimately, a sharp upward revision to October and healthy control group results (4.4%) point to strength for 4Q GDP.
- AAII Investor Sentiment cratered last week to 20.9%, the lowest level since the 2016 selloff.
- JOLTS job openings climbed 1.7% in November to 7.079mm, just shy of August's record of 7.293 mm and still over 1mm above the number of unemployed persons seeking work. The quit rate fell 1.4%, a welcomed indicator for Fed quits which fell 1.4 percent to 3.514 million from September with the year-on-year rate, at 5.7 percent, only slightly elevated.
- November NFIB Small Business Optimism Index drifted to its lowest level in seven months at 104.8 but sits only 4 points below an all-time high. Lack of qualified labor and associated wage pressures were the primary negative sentiments.