Opinion | Markets have no time for good economic news
The JPMorgan Global FX Volatility Index has risen to 8.78, below its high for the year of 9.29 in August and just below its average of 8.91 over the last five years
Stocks were on their way to their second consecutive big decline on Thursday, with the S&P 500 Index dropping as much as 2.91% after Tuesday’s 3.24% tumble. (Markets were closed Wednesday to mourn the death of former President George H.W. Bush.) But then a rebound in tech shares helped cut the losses to a mere 0.15 percent. Still, questions remain about why equities are so volatile. There are three primary reasons: 1) A trade war between the US and China that drags on with no real path to resolution; 2) Bond market yield curves becoming inverted; and 3) Slower corporate profit growth. If the focus were solely on the actual economy, the mood on Wall Street might be markedly better.
Of the three, I’d guess that the violent moves in the bond market over the past week have had the greatest impact, given that an inverted yield curve has historically preceded a recession. It doesn’t matter than only a small portion of the curve has inverted, with yields on five-year Treasury notes falling below those on three-year notes. The general sense among investors is that it’s only a matter of time before the whole curve inverts, tanking markets. That may sound scary, but it’s not as if a recession would start the next day. In fact, it took an average of 21 months for a recession to start after each of the last five (substantial) yield curve inversions going back to 1980, according to Deutsche Bank. Then there’s the fact that the economic data are pretty good. The Institute for Supply Management said Thursday that its index of US service industries rose unexpectedly in November to a near-record level. On Friday, the government is forecast to say that the economy added about 200,000 jobs last month with wages rising the most since 2009. AllianceBernstein’s former global director of economic research Joseph G. Carson has recommended investors look at what he calls the economic yield curve, which is still wide, rather than focusing on the bond market’s yield curve.
The economic yield curve is the spread between the federal funds rate and nominal gross domestic product. According to Carson, this relationship is important because it’s the ability of consumers and businesses to carry or afford higher borrowing costs that could eventually impact economic growth. Based on third-quarter data, the economy’s yield curve is about 350 basis points, consistent with a positive growth outlook. The average spread during the 1990s growth cycle was 100 basis points and in the 2000s it was 200 basis points. Moreover, history also shows that a flat or an inverted spread between the fed funds rate and the growth in nominal GDP always precede a slowdown or recession. “If you look at the economic data we see a clear story: We will not have a recession anytime soon,” Torsten Slok, Deutsche Bank’s chief international economist, wrote in a research note Thursday.
The Fed’s being priced out
Of course, using current economic data is inherently backward looking, and there’s no guarantee that the economy won’t deteriorate rapidly. S&P Global Ratings issued a report Tuesday forecasting that US economic growth will slow from 2.9% in 2018 to 2.3% in 2019 and 1.8% in 2020. And the drop in yields in the market for US Treasuries is largely an acknowledgment of the coming slowdown and the likely need for the Federal Reserve to slow the pace of interest-rate increases. Futures show there’s about a one in three chance the central bank won’t raise rates when policy makers meet in two weeks — something that was seen as a foregone conclusion just last week. For 2019, almost no rate increases are being priced in by futures, down from the three seen just a few weeks ago. Fed officials are expressing concern and urging caution in regard to monetary policy. “I currently think we’re within shouting distance of neutral, and I do think neutral is where we want to be,” Federal Reserve Bank of Atlanta President Raphael Bostic said Thursday regarding the current level of interest rates. Federal Reserve Bank of Dallas President Robert Kaplan, in an earlier interview on CNBC, said “at this stage, you’re going to hear me be a lot more cautious and counsel patience.” Both are considered “doves” on monetary policy.
One area of the global markets that is looking surprising calm is currencies. Despite all the hand-wringing about a global synchronized slowdown and trade wars, the JPMorgan Global FX Volatility Index has only risen to 8.78, below its high for the year of 9.29 in August and just below its average of 8.91 over the last five years. To put that in context, the CBEO Volatility Index, or VIX, of US stocks was 23.45 on Thursday, above its average of 14.73 over the past five years. The relative calmness among currency traders may be a sign that they don’t believe that leading central banks will be able to extricate themselves from global financial markets as quickly as thought because of a looming economic slowdown. The International Monetary Fund downgraded its forecast for world growth last month, and Managing Director Christine Lagarde warned last week that the outlook might have become even worse. The Bank of Canada’s policy meeting Wednesday was a good example of what Lagarde was talking about. The central bank pointed to signs of slower-than-expected growth when it left interest rates unchanged, leading traders to trim bets for a rate rise in January. “My bet is the BoC is done, period,” David Rosenberg, chief economist and strategist at Gluskin Sheff + Associates Inc., told clients in a report this week.
Follow the money
If investors really expected things to get really bad, really fast, then emerging markets would be persona non grata. And while emerging markets have had trouble, with the MSCI EM Index of equities dropping more than 26% between late January and late October, they have been little changed since then as developing markets sold off. The same is true of emerging-market currencies. The Institute of International Finance in Washington calculates that portfolio flows into emerging markets surged to $33 billion last month from $2.2 billion in October. That’s hardly what would be expected when global investors are largely thought to be in de-risking mode or if a steep global economic slowdown was imminent. Of the money that flowed into emerging markets in November, $12 billion went toward equities and $22 billion toward debt, which was the most since April. Morgan Stanley, BNY Mellon Asset Management, GAM Ltd. and SEB SA have all affirmed their favourable views on emerging markets, saying in part that the steep rout suffered earlier this year has created attractive valuations, according to Bloomberg News’s Aline Oyamada and Netty Ismail. Morgan Stanley went so far as to say in a research note Thursday that “the bear market in EM is over.” Alas, such comments weren’t enough to keep the MSCI EM Index from dropping 2.25% on Thursday in its third consecutive decline.
OPEC disagreements sink oil
A lot of attention was being paid to the oil market on Thursday. That’s because OPEC ended talks without a deal on oil production cuts for the first time in nearly five years as Russia flexed its muscles by refusing to commit so far to the big output curb that Saudi Arabia is demanding, according to Bloomberg News. Oil prices promptly fell, with West Texas Intermediate dropping as much as $2.81, or 5.31%, to $50.08 a barrel. After two days of talks in Vienna, Saudi Energy Minister Khalid Al-Falih said he isn’t confident of an agreement when meetings resume Friday. A proposal for a combined OPEC and non-OPEC cut of 1 million barrels a day was left dangling. Oil has plunged from about $77 a barrel in early October, with many saying a drop in demand is as much to blame as a glut a supply. That’s not a sign of a strong economy. Lower oil prices are also contributing to the rally in Treasuries and other sovereign bond markets. That’s because the decline is causing inflation expectations to drop, fuelling even more speculation that central banks will favour caution when it comes to tighter monetary policy. Breakeven rates on five-year Treasuries — a measure of what bond traders expect the rate of inflation to be over the life of the securities that is closely watched by the Fed — dropped below 1.70% on Thursday for the first time since September 2017. The breakeven rate was as high as 2.20% in May.
The US Labor Department on Friday will release its monthly report on the health of the job market. The consensus is that payrolls jumped by 195,000 in November. Although that would be down from October’s better-than-forecast reading of 250,000, it’s right in line with the average of 194,000 over the past two years. Average hourly earnings are expected to rise by a solid 0.3%. So, nothing to worry about, right? Maybe not. The top-ranked interest rates strategists at BMO Capital Markets pointed out in a research note Thursday that 12 proxies they track are slightly negative, with seven suggesting an upbeat report and five flagging a downbeat report. With so much hand-wringing over the signals being sent by the bond market in regard to a slowing economy, a poor jobs report could send investors over the edge.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Robert Burgess is an editor for Bloomberg Opinion. He is the former global executive editor in charge of financial markets for Bloomberg News. As managing editor, he led the company’s news coverage of credit markets during the global financial crisis.
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