The Market Today
Escalation of Trade Conflict Continues Raising Uncertainty for Investors and Economists
by Craig Dismuke, Dudley Carter
Jobless Claims Show No Reaction to Increased Uncertainty: Initial jobless claims for the week ending May 18 fell from 212k to 211k. Clearly, the recent breakdown in trade talks has not hit the fast data yet. Perhaps the labor market is so tight that it will be immune to the increase in uncertainty. Nevertheless, the labor data continues to look strong despite the uncertainty.
New Home Sales, PMIs, Regional Manufacturing Report, Fedspeak: At 8:45 a.m. CT, the Markit manufacturing, services, and composite PMIs are expected to show slight progress in May. More importantly, April’s new home sales report, scheduled for 9:00 a.m., is expected to show a 2.5% decline after jumping 4.5% to the second highest level of the cycle in March. The Kansas City Fed’s report on regional manufacturing activity is slated for 10:00 a.m. There are a handful of Fed officials speaking on a panel at noon. However, panel discussions rarely generate market-moving headlines.
Yesterday – Trade Remains Atop the List of Worries: Overnight reports that the U.S. was considering blacklisting other Chinese companies erased optimism created by the Huawei exceptions and led the major equity indices to erase a portion of Tuesday’s rise. The Dow and S&P 500 both spent the entire session in negative territory, ultimately dropping 0.4% and 0.3%, respectively. The more defensive sectors were among the five that rose while financials, technology, and industrials were in the group of six sectors that weakened. Energy companies, however, led all losses as U.S. WTI crumbled 2.7% under the demand pressure of the trade anxieties that were amplified by a supply-heavy report from the EIA showing total product inventories grew and production ticked higher. In addition to those forces, lower yields across Europe also weighed on the Treasury curve which flattened to 15.7 bps between 2s and 10s, the lowest since April 11. The 2-year yield dropped 3.1 bps to 2.22% while the 10-year yield fell 4.4 bps to 2.38%. Globally, only the U.K. saw larger declines as Brexit chaos continued and one of PM May’s top cabinet officials resigned. While they did not have a perceptible impact on the intraday chart, the Fed’s Minutes (more below) were also consistent with lower yields.
Overnight – Investor Angst Remains High as Trade Tensions Roll On: Global investors are becoming increasingly impatient with the uncertainty surrounding the continual ratcheting up of trade tensions, with the most recent escalation of the rhetoric revolving around U.S. actions targeting Chinese tech companies. Global equities pulled back again Thursday as trade tensions roll on, the risk-off tone driving up prices (down yields) on core sovereign debt. China’s CSI 300 sank 1.8% to lead losses across Asia and set the negative tone early. The Stoxx 600 fell as much as 1.5% earlier and U.S. futures had pulled backed 0.9%. Treasury yields declined and were flirting with their lowest levels since early 2018. China’s Commerce Ministry spokesman said Thursday, “China’s stance on the talks has been clear – if the U.S. wants to resume talks, they should show sincerity and correct their wrong practices, …Only on a basis of equality and mutual respect can the talks continue.” The comments came less than twenty-four hours after U.S. Treasury Secretary Mnuchin said another trip to Beijing had not yet been planned. The 2-year Treasury yield touched 2.185% overnight, just 4.8 bps above its lowest level since February 2018. The 10-year yield dropped as far as 2.345%, less than 1 bp from setting a new low back to December 2017. Other factors, however, were also keeping yields weighed down. U.K. yields continued to set the pace for declines across Europe in the face of an increasingly uncertain path for Brexit, oil prices extended yesterday’s drop resulting from swelling U.S. supplies, and key European economic data disappointed. The Eurozone’s composite PMI edged up less than expected in May as the manufacturing component pointed to a fourth month of contraction, falling back near a six-year low. A popular survey gauging the German business environment also disappointed, falling to its lowest level since 2014.
Fed Minutes Showed the Committee’s Patience is Likely to Persist for “Some Time”: The Fed’s May Minutes indicated officials were more comfortable with their patient posture when they met earlier this month, and signaled that any future changes to rates will be heavily dependent on inflation trends. Economic activity had improved after a slow start to 2019 and officials listed several “factors likely to support solid growth over the remainder of the year.” Some officials “viewed risks to the downside…as having decreased, partly because prospects for a sharp slowdown in global economic growth, particularly in China and Europe, had diminished,” but “most participants observed the downside risks to the outlook…remain.” However, continued improvement in the outlook may not be enough to spur the Fed to raise its overnight rate. “Members observed that a patient approach … would likely remain appropriate for some time, especially in an environment of moderate economic growth and muted inflation pressures, even if global economic and financial conditions continued to improve,” the Minutes noted. On inflation, “many participants viewed the recent dip in PCE inflation as likely to be transitory,” but some “viewed the downside risks to inflation as having increased” and some were concerned about the impact to expectations. There was lengthy discussion about the long-run maturity composition of the portfolio that weighed the costs and benefits of different approaches, but no final decisions were be made. And the drifting up of the effective Fed Funds rate, that led to another technical IOER adjustment in May, continued to be blamed on factors other than a scarcity of reserves.
Fiscal Deal and Debt Limit Increase Take a Hit: President Trump left meetings with Democrats to discuss an infrastructure deal, lifting the sequester cuts, and/or raising the debt limit yesterday before the meeting earnestly began. Meanwhile, Treasury Secretary Mnuchin warned that the debt ceiling would need to be lifted by the end of summer. That date is likely a conservative estimate, as is the practice of Treasury to leave themselves some wiggle room.
Full-Blown Trade War?: According to a Bloomberg headline this morning, a “full blown trade war quickly shifting from risk to baseline” for economists. While economists have increased the odds of a prolonged trade battle, only a handful of economists have raised the probability of a full-blow trade war to their basecase outlook. Rather, the general view is that both sides are willing to take this further than initially believed and the short-term economic impact could be more damaging. As this outlook has evolved, the risks to a near-term recession and lower fed funds rates have increased. The Bloomberg article cites Nomura economists saying, “The U.S.-China relationship has moved further off track over the past two weeks after a period of what appeared, on the surface, to be steady progress towards reaching an admittedly narrow agreement… We do not think the two sides will be able to get back to where they seemed to be in late April.” If the trade war were to continue escalating, we view the risks to global and U.S. recessions as high.