It may all be quiet across financial markets for now, however the week picks up with an array of data releases and key events. The European Central Bank meets on Wednesday, ahead of US inflation data and the release of Federal Reserve minutes from its March gathering.
With cherry blossoms swirling, the IMF and World Bank hold their spring meetings in Washington, where the outlook for the global economy is one of a “synchronised slowdown” and one that looks hard to reverse in 2019.
Such gloominess is reflected by slumbering government bond yields in the developed world. In contrast, the message from global equities stalking their record peak of 2018 is one of optimism that dovish central banks and China’s stimulus will keep the risk show on the road. Picking apart the power of China stimulus is outlined in Quick Hits below.
Meanwhile, here’s how the FTSE All-World equity index looks after its strong rebound in recent months:
A glance at the chart shows we are nearing an important moment for risk appetite. A double top beckons for equities should the rebound in economic data prove less soothing than hoped. The S&P 500 index has led the way and is far closer to last year’s peak than other global markets. So that’s the market to watch, particularly as the start of US corporate earnings season may dent sentiment should companies disappoint on their guidance for later this year. Wall Street is already looking beyond the first negative year-over-year quarterly earnings season since 2016. The consensus thinking is that the first quarter of 2019’s expected decline of 3.9 per cent for S&P 500 earnings growth will mark a trough, but that may prove rather optimistic.
Michael Wilson at Morgan Stanley argues that the recovery in share prices this year reflects how a dovish Fed has rolled back tight financial conditions. The problem for the markets is that the shot of US fiscal stimulus last year has left a legacy of corporate cost pressures and tightening margins.
As he explains:
“I think it’s misguided to assume that the profits recession has magically ended, and I see an increasing chance that it turns into an economic one if companies decide they want to protect profits by cutting labour, capex and inventory.”
In that regard, rising oil prices are another cost factor to watch as the price of Brent pushes beyond $70 a barrel to its highest point since mid-November. Opec remains focused on getting prices higher through production cuts, with a worsening conflict in Libya helping to achieve that aim. At some point, oil feeds through to the broader economy as a higher tax on drivers.
Still, as TD Securities cautions, not even Saudi Arabia, the key player in Opec, wants to see prices rise too quickly:
“Saudi, which has been shouldering more than its fair share of the cuts, may see any further disruptions as an opportunity to open up the taps, lest prices surge to levels that would incentivise a boost in non-conventional production.”
In the US bond market, rising oil prices work in a couple of ways. A tax on the consumer fans the expectation of a US interest rate cut by the Fed later this year. By contrast, the 30-year bond yield has risen relative to shorter-dated Treasury notes, such as the five-year. This steeper yield curve relationship partly reflects how higher oil should feed rising headline inflation in the coming months.
Of this week’s central bank line up, no one really expects much from the ECB, while the extent of the dovish shift at the Fed will entertain traders and pundits.
The US bond market clings to the view that the next shift from the Fed is an easing, as seen by the federal funds futures contract for January 2020. That provides a clean look for where the Fed’s overnight rate will end this year. Currently the contract implies a rate of 2.24 per cent (100 minus the futures price of 97.76).
The market has eased a touch from the closing peak of 97.05 in late March, but as the chart above shows, it remains another world since November when the contract was implying a rate of almost 3 per cent by the end of this year.
John Brady at RJ O’Brien sums up the situation for rate traders:
“We are waiting for either the economy, inflation or financial conditions to shift meaningfully to price the next rate-trade; the Fed’s reaction function to a downside growth or inflation scare is very sensitive at the moment.”
The meeting minutes are likely to show there is a pretty high bar for the Fed making a policy move in either direction at the moment. The big easing in financial conditions since late December and a moderating economy should keep the US central bank in a holding pattern for some time.
Any call for tighter policy looks a lot tougher, unless the US economy shows a lot more resilience and core inflation sustains a firmer pace. Given the Fed’s nascent signs of tolerating greater inflation pressure after undershooting for much of the decade, any late-cycle shift higher in the funds rate is more a 2020 story and even that looks a stretch from here.
For the rest of this week fastFT will keep Market Forces readers updated, until I return next week.
Quick Hits — What’s on the markets radar
This time it’s different; China stimulus — Plenty rides on Beijing firing up the engines for emerging markets and Europe, given the slowdown seen for German manufacturing, with new data out today, showing imports and exports fell in February.
In the camp that history does not repeat, comes an interesting view from Citi’s global strategy and macroeconomic outlook. It argues that Beijing’s current stimulus “is both more decentralised and consumption orientated than in past episodes” and this approach has two implications:
“First, the scale of the economic boost is more heavily mediated by domestic Chinese economic confidence — adding a layer of uncertainty. Second, the ‘traditional’ benefits of a Chinese stimulus to the rest of EM are likely to prove less extensive this time around.”
This suggests less demand from China for intermediate goods and commodities exported by other EM countries and developed economies such as Canada and Australia.
And then there’s Europe, whose trade-dependent economy is not looking so good. Citi conclude that the nature of China stimulus is not going to move the dial:
“The implication of this is a broader, trade-driven, eurozone strengthening, and an associated strengthening in EUR/USD, seems unlikely.”
Sticking with China, here’s the Institute of International Finance looking at the country’s debt trajectory and how this could well stymie Beijing’s policy of deleveraging the economy:
“While the pledge from China’s authorities to align credit growth with nominal GDP growth suggests a pause in deleveraging, the ongoing slowdown in producer price inflation could feed into weaker nominal growth, meaning that already-high debt levels could rise again this year.”
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