Not all gloom(y data) spells doom and, equally, nor is it all gold that glitters
- Trade war hurts confidence and sentiment, but the current reality looks less bleak
- Does the Fed’s cautious stance help or detract?
- Pressures are building, but is a breaking point in sight?
Recent, depressed, survey data on business and consumer confidence has reflected anxiety over the outcome of the trade fight between the US and China. As forward-looking – leading – indicators of business prospects and, by extension, the direction of the economy, they have painted a despondent picture. But according to the hard data, the economy’s actual performance has been rosier, though perhaps not as glittery as it was 6-12 months ago. And this is not the global picture.
Instead, recent numbers have flagged up reasons to be concerned over the outlook for China and Europe, where the slowdown in global trade has hit hardest. By comparison, US strength has held up, particularly on the services and consumption side, even in the wake of the just over 5% rise in crude oil prices after the recent attacks on Saudi oil installations. Given that the US is now the world’s largest crude oil producer, the limited impact of dearer oil on the economy is perhaps unsurprising. By contrast, China is the world’s largest importer, while five of the top-10 importers are European.
Exhibit 1: Economic surprise data: a steep climb in the US index
Data as at 12 September 2019; source: Citibank, BNP Paribas Asset Management
Tariffs are hurting China (and the eurozone)… and eventually the US?
However, it is overall trade, not just oil trade, that ranks top among the market’s current topics – and concerns. This has clearly clouded sentiment and led to questions over the sustainability of US growth: can it last; will it spread to other economies as strong US demand is exported abroad; what is the risk that (now resilient) hard data follows (trade-torn) soft data as was the case at the end of 2018 and the beginning of 2019?
How will the US central bank react in either case? The Federal Reserve has recently cut interest rates again, but also appears to be signalling an end to such moves further down the line. Policymakers’ expectations –known as the FOMC dot plot – have shifted: indications are now calling for one more cut in the federal funds rate before a spell of stability and then a move to gradual increases.
Fewer Fed cuts mean what exactly?
Such a stance could point to greater optimism among Fed governors about the economic outlook and the prospects for inflation. By contrast, the market – in the shape of fed funds futures – is more bearish, assuming a low for the benchmark fed funds rate that is actually 50-75bp below the nadir in the FOMC dot plot.
That divergence– call it arm-wrestling between the Fed and the market – is not new, though it is worth pointing out that, historically, the market has been ahead of the Fed in lowering its inflation – and hence interest-rate – expectations, with the Fed then adjusting its view.
With a cautious Fed signalling fewer fed funds cuts than the market anticipates, equities have lost part of the support that has been behind the 20%-plus gain for the US S&P 500 index so far this year. Instead, the concern is that a lack of further rate cuts by the US central bank will ultimately result in disappointing growth and inflation.
Waiting for more clarity from the Fed (and the data)
However, until the market gets a different message from the Fed, possibly under presidential pressure or as hopes rise for a trade deal, investors should be able to look forward to some stability – at least for bond yields.
Given the global significance of Fed policy, it plays a key role in determining market, investor and economic sentiment. Will the US central bank’s caution translate into gloom or will weak industrial production and other data force China back to the negotiating table and leave it with no choice but to do a deal (and relieve the pressure on global trade and growth)? The market, and a US president looking for re-election, would seem to wish for such a glittering finale to a volatile year.
For more posts by Daniel Morris, click here >
For more charts of the week, click here >
To discover our funds and select the ones that meet your requirements, click here >
Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.