The Market Today
Fed Cut Likely as Trade Situation Devolves
by Craig Dismuke, Dudley Carter
THIS WEEK’S CALENDAR
Important Week for Data to Confirm or Refute Growing Investor Gloom: This week’s economic calendar is of paramount importance with the data either confirming the growing fears that the trade uncertainty is spreading from the manufacturing sector to other sectors, or that the growing fears are overdone. After the Markit PMI reports two weeks ago showed that the damage was spreading to the services sector, and perhaps dented the otherwise-resilient labor market, investors’ fears have escalated. The markets now show an expectation for the Fed to cut two times before year-end, followed by at least one cut in 1H20. Notable economists, who were exceedingly hawkish coming into the year, have completely reversed their forecasts with many now calling for multiple rate cuts. The trade negotiations have already devolved worse than expected. Every day that the uncertainty persists, the more likely it becomes that the Fed will be forced to accommodate a flagging economy. Adding the new tariffs placed on Mexican imports to the calculus, we will be lowering our interest rate and growth projections later this week, including a 25 basis point rate cut in the second half of the year.
This morning’s ISM Manufacturing Index (9:00 a.m. CT) will be the first chance to see the impact on the sector most acutely affected by trade uncertainty. Wednesday will bring the ISM Non-Manufacturing Index which will be the more important report, showing if the impact is spreading. And Friday’s May employment reports will show us if the fears are spreading to businesses’ hiring decisions. Thus far, the labor market has remained mostly unfazed.
Also worth watching, there will be a flurry of Fedspeak early in the week, including New York Bank President Williams and FOMC Chairman Powell on Tuesday. To date, Fed officials have cited the need for patience but have stopped short of saying they may need to cut rates.
Today’s Calendar – Construction, Autos, and Fedspeak: Also on today’s calendar will be the construction spending report for April, auto sales in May, and comments from three Fed officials: Quarles, Barkin, and Bullard.
Overnight – June Kicks Off with More Worries About World Trade: Global markets started June much the way they wrapped up May, with investors opting for safer investments in the face of an increasingly uncertain outlook for global trade and broader economic activity. A positive PMI (50.2) covering smaller-to-medium-sized Chinese companies countered last week’s contractionary report (49.4) for state-run companies, but failed to offset the broader concerns. The Chinese government published an official response to the White House’s claim that China backed away from commitments it made during negotiations, saying it was U.S. negotiators who were to blame for talks breaking down. Accompanying that report, a vice minister from China’s Commerce Ministry said, “During the consultations, China has overcome many difficulties and put forward pragmatic solutions. However, the U.S. has backtracked, and when you give them an inch, they want a yard.” Chinese equities were mixed in a similarly uncertain day across the continent. The Eurozone’s manufacturing PMI was unchanged in revisions, holding just above March’s six-year low and confirming a fourth consecutive month of contraction. The U.K.’s PMI fell more than expected in May, contracting for the first time since the July after voters chose to leave the EU in 2016. Yields in the U.K. led declines across Europe, with the 10-year yield down 1.5 bps to 0.87%, the lowest since October 2016. There was an even greater bid for U.S. Treasurys ahead of a couple of key reports on U.S. manufacturing. The 2-year yield was down 4.8 bps to 1.87% just after 7:15 a.m. CT, a new low since December 2017, while the 10-year yield edged down 1.4 bps to 2.11%, a new low back to September 2017. S&P 500 futures were down 0.3%.
ICYMI – May 31, 2019 Weekly Market Recap: The U.S.’s use of tariffs took an unexpected turn last week that sent the S&P 500 tumbling through its 200-day moving average and the Treasury curve, between the 2- and 10-year notes, through the bottom of the Fed’s target funds range. There were several important economic reports last week – a better-than-expected GDP revision, solid consumer spending and confidence, weaker-than-expected housing, and firmer April inflation – but all of those were drowned out by the drum beat of trade angst. It started with a carryover of the China tensions after President Trump said the U.S. wasn’t ready to make a deal yet since China reneged on its commitments. Then reports indicated China was considering cutting off exports of rare earths to the U.S. as a “weapon” of retaliation. But the sharpest rate volatility came Friday after President Trump’s surprise announcement that beginning on June 10, the U.S. would impose a 5% tariff on all Mexican imports unless Mexico helps end the flow of illegal immigrants across the border. The tariff rate will increase each month until it reaches 25% in October, or until the White House is satisfied with Mexico’s efforts to remedy the immigration issues. The 2-year yield fell 14 bps alone on Friday, was down 24 bps for the week, and ended at 1.92%, its lowest level since January 2018. The 5-year yield fell 21 bps on the week to 1.91%, its lowest since October 2017, and the 10-year yield dropped 20 bps to 2.13%, its lowest yield since September 2017. Amid the chaos and concerns that tariffs will heavily impact economic growth, Fed Funds futures repriced to reflect 50 bps of Fed easing by the end of the year. Click here to view the full recap.