Weekly: Mood swings
- However, positive news out of China, Hong Kong, Italy, UK, and the US could easily fade
- The frenzy of flight to safety and negative yields could be ending
- Surging US wages and labour cost data are being ignored
- Considerable volatility in the fixed income market could ensue
A market exhausted from August’s ups and downs has found sources of relief in the early days of September. So far this week, five important developments have helped:
• China: Better than expected activity report, in the form of Caixin services PMI for August, broke a string of underwhelming data. The PMI report’s job creation component was encouraging in particular, which helped assuage concerns about the ongoing slowdown in the world’s most populous economy.
• Hong Kong: Chief Executive Carrie Lam stated earlier this week that the controversial extradition bill that had sparked this summer’s protests will be withdrawn. Additionally, reports emerged that Chinese Vice President Wang Qishan has played a key role in helping matters.
• Italy: A highly volatile political crisis that brought the government close to a collapse last month was resolved this week as PM Conte put together a new cabinet with representatives from the left and right.
• UK: Signs emerged this week, amid numerous parliamentary manoeuvres and votes, that the October 31 Brexit cliff-edge (deal or no-deal Brexit, as vowed by PM Johnson) will likely be avoided.
• US: In contrast to the poor manufacturing PMI, ADP data released this week show that jobs growth picked up strongly in July, in both manufacturing and services. The ISM non-manufacturing reading was also positive.
We will urge caution against this backdrop. In each of these developments, there was little by way of conclusive resolution. Let’s begin with China, where manufacturing and sales data remain poor. Even the Caixin report that pleased the markets shows export orders pulling back. For the all the talk of trade talks resuming in October, the fact remains that tariffs were raised further just a few days ago. China’s headwinds remain considerable.
In Hong Kong, it is yet to be seen if the extradition bill’s withdrawal will be sufficient to stem fomenting discontent. While the bill’s introduction was the trigger that sparked the protests, it is clearly understood that grievances run deep and wide.
Italy’s new coalition is fledgling at best; questions remain if an alliance between traditional antagonists (the populist Five Star and centre-left Democratic Party) will hold for more than a year.
In the UK, many pitfalls lie ahead. PM Johnson could choose to ignore the bills passed by the opposition to force the October 31 Brexit deadline; he could even bring a no-confidence motion (which requires a simple majority to pass) against his own government to ensure an election before October 31.
Finally in the US, good data may well be bad news for the markets. Several regional governors are against further monetary accommodation at this juncture, although markets are convinced from recent observations made by Chair Powell and New York Fed president Williams that another rate cut is around the corner and there will be even more before the year is over. In this politically charged environment, and rising nervousness about the global economic outlook, the Fed’s position is increasingly tenuous. As markets rally in expectation of a trade deal and jobs data remain strong, the inclination to provide immediate accommodation recedes, but a Fed pause in September will shock the markets. The Fed may well be hostage to that risk.
We also hope that in the middle of flight to safety, negative yields, inverted curves, and stable core PCE inflation, Fed officials take note of other compelling data that show that wages and costs are rising. Latest productivity data from the Bureau of Labour Statistics show that hourly compensation has surged this year, pushing up unit labour costs. Under ordinary circumstances, this report alone would set off warning bells of incipient inflationary pressure. We would at least hope Fed communication picks this up later this month. But if it does indeed do that, the markets (not to mention President Trump) will be highly displeased. Mood swings are likely to be par for the course.
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