Market Volatility Continues To Compress

The US Independence Day holiday kept trading, market activity and volatility subdued for much of last week.  In any case equity markets and risk assets have been struggling on the topside and appear to be losing momentum.  Markets are being buffeted by conflicting forces; economic news has beaten expectations. For example, the US June jobs report was better than expected though total job gains of 7.5 million in recent months are still only around a third of total jobs lost.  In contrast, worsening news on Covid 19 infections, with the WHO reporting a one day record high in global infections, threatens to put a dampener on sentiment.  Consolidation is likely, with Summer trading conditions increasingly creeping in over the weeks ahead. As such volatility is likely to continue to be suppressed, aided by central banks’ liquidity injections.

Over recent weeks geopolitical risks have admittedly not had a major impact on markets but this doesn’t mean that this will remain the case given the plethora of growing risks.  China’s installation of new security legislation into Hong Kong’s basic law and the first arrests utilizing this law were in focus last week.  A US administration official has reportedly said that the president is considering two or three actions against China, and markets will be on the lookout for any such actions this week, which could include further sanctions against individuals are more details of what the removal of HK’s special trading status will entail.  Meanwhile the US has sent two aircraft carriers to the South China Sea reportedly to send a message against China’s military build up in the area, with China’s PLA conducting a five-day drill around the disputed Paracel Islands archipelago.

Data releases and events this week are unlikely to lead to a change in this dynamic.  At the beginning of the week attention will focus on further discussions between the UK and EU over the post Brexit landscape while in the US the June non-manufacturing ISM survey will garner attention.  So far talks on a trade deal between the UK and EU have stalled though there were hints of progress last week, even as officials admitted that “serious divergencies remain”.  The US ISM non-manufacturing survey is likely to move back to expansion (above 50) but is increasingly being threatened by the increase in Covid infections, which could yet again dampen service sector activity. On the policy front there will be fiscal updates from the UK and Canada on Wednesday against the backdrop of ramped up spending, and monetary policy decisions by the Reserve Bank of Australia (RBA) and BNM in Malaysia on Tuesday.  The RBA is widely expected to keep policy unchanged while BNM may cut rates by 25 basis points.

 

Fed, ECB, BoJ In Focus This Week

Three major central banks meet to decide on monetary policy this week, but after massive and unprecedented actions over past weeks, there is likely to be little new in terms of additional policy measures announced by the US Federal Reserve (Fed), European Central Bank (ECB) and Bank of Japan (BoJ) in the days ahead.  Key data this week include US Q1 GDP, the April US ISM manufacturing survey and China’s April purchasing manager’s index (PMI).

The Fed has thrown everything but the kitchen sink at Covid-19 to combat the severe economic and market impact emanating from the virus.  This included aggressive rate cuts, unlimited asset purchases (Treasuries, MBS), purchases of commercial paper, loans to small businesses, easing rules for banks and provision of US dollar swap lines with other central banks to help ease global USD demand pressures.  Aside from some fine tuning, there may not be much else the Fed will do at its meeting on Wednesday. Meanwhile the US ISM survey (Fri) is likely to post a sharp decline (consensus 37.0).

Markets have reacted well to the measures announced and implemented so far, but as noted there is a growing disconnect between the rally in equity markets over recent weeks and rapidly worsening economic data.  US Q1 GDP data (Wed) this week will likely reveal some of the damage, with a 4% q/q annualised fall in GDP forecast by the consensus. Q2 GDP will be even weaker however, as most of the weakness in activity will have taken place in April and will have likely continued into May and June.

The ECB continues to face pressure to do more as Eurozone activity continues to plunge.  So far the main thrust of the ECB’s measures are EUR 750bn of bond purchases and loosening of restrictions on such purchases.  However, sovereign spreads, especially in the periphery (especially Italy) are under pressure and the ECB may need to act again soon though perhaps not as early as the meeting this Thursday.  The ECB will also likely shift the onus of further easing to fiscal, especially the proposed “recovery fund”, which continues to fuel major divisions between European countries.

Last but not least the BoJ meeting on Monday will probably be the most active in terms of new measures, but on balance they will probably do little to move markets.   At the last meeting the BoJ significantly increased the amount of ETFs they would purchase, which to some extent has helped the Nikkei 225 rally over recent weeks.  At this meeting the BoJ is unlikely to alter its negative interest rate policy, but is likely to remove its JPY 80 trillion cap on JGB purchases and announce an increase in corporate bond purchases along with other measures to ease credit.

On the data front China’s official manufacturing PMI is likely to remain around or just above the expansionary threshold of 50 as much of China’s supply side of the economy opens up.  However, the ability to retain expansion at a time when global demand and therefore China’s export markets are collapsing, will prove difficult.  China’s authorities appear to be increasingly realising this and have stepped up support both on the fiscal (via special bond issuance) and monetary side (targeted cuts in various rates), but so far the scale of easing has been limited and Q1 growth was especially weak.

Calm After The Storm

The start of 2020 has not come without incident, to say the least.  The US killing of an Iranian general and Iranian missile strikes on US bases in Iraq prompted a flight to safety, with investors piling into gold, Japanese yen while pushing oil prices higher.   However, each time the impact has been short lived, with markets tending to move back towards a calmer tone.  What is underpinning this is the view that both sides do not want a war.  Indeed Iran stated that it has ‘concluded proportionate measures’ and does not ‘see escalation or war’ while President Trump tweeted that ‘All is well’ after the Iranian missile attacks. While the risk of escalation remains high, it does appear that neither side wants to become entangled in a much deeper and prolonged situation.

As such, while markets will remain nervous, and geopolitical risks will remain elevated, the market’s worst fears (all-out war) may not play out.  This leaves the backdrop of an improving economic environment and ongoing policy stimulus in place, which in turn will help provide overall support to risk assets including equities and emerging markets assets.  As my last post highlighted, two major risk factors threatening to detail market sentiment into year end were also lifted.  Unless there is a major escalation between the US and Iran this more sanguine tone, albeit with bouts of volatility, is likely to remain in place in the weeks ahead.  This also mean that attention will eventually turn back to data releases and economic fundamentals.

In this respect the news is not so bad.  Although the US ISM manufacturing index weakened further and deeper into contraction territory below 50 other data including the ISM non-manufacturing index which beat expectations coming in at , suggests that the US economy is still on a rosy path.  While the consensus expectations is for US payrolls to soften to a 160k increase in December compared to 266k previously, this will still leave a high average over recent months. The Fed for its part continues to provide monetary support and liquidity via its repo operations (Quantitative easing with another name) and is unlikely to reverse rate cuts.   Elsewhere globally the economic news is also improving, with data showing global economic stabilization into year end.

China Data Fuels A Good Start To The Week

Better than expected outcomes for China’s manufacturing purchasing managers indices (PMIs) in November, with the official PMI moving back above 50 into expansion territory and the Caixin PMI also surprising on the upside gave markets some fuel for a positive start to the week.   The data suggest that China’s manufacturing sector has found some respite, but the bounce may have been due to temporary factors, rather than a sustainable improvement in manufacturing conditions.  Indeed much going forward will depend on the outcome of US-China trade talks, initially on whether a phase 1 deal can be agreed upon any time soon.

News on the trade war front shows little sign of improvement at this stage, with reports that a US-China trade deal is now “stalled” due to the Hong Kong legislation passed by President Trump last week as well as reports that China wants a roll back in previous tariffs before any deal can be signed.  Nonetheless, while a ‘Phase 1’ trade deal by year end is increasingly moving out of the picture, markets appear to be sanguine about it, with risk assets shrugging off trade doubts for now.  Whether the good mood can continue will depend on a slate of data releases over the days ahead.

Following China’s PMIs, the US November ISM manufacturing survey will be released later today.  US manufacturing sentiment has come under growing pressure even as other sectors of the economy have shown resilience.  Another below 50 (contractionary) outcome is likely.  The other key release in the US this week is the November jobs report, for which the consensus is looking for a 188k increase in jobs, unemployment rate remaining at 3.6% and average earnings rising by 0.3% m/m. Such an outcome will be greeted positively by markets, likely extending the positive drum beat for equities and risk assets into next week.

There are also several central bank decisions worth highlighting this week including in Australia, Canada and India.  Both the Reserve Bank of Australia (RBA) and Bank of Canada (BoC) are likely to keep monetary policy unchanged, while the Reserve Bank of India (RBI) is likely to cut its policy rate by 25bps to combat a worsening growth outlook.  Indeed, Q3 GDP data released last week revealed the sixth sequential weakening in India’s growth rate, with growth coming in at a relatively weak 4.5% y/y. Despite a recent food price induced spike in inflation the RBI is likely to focus on the weaker growth trajectory in cutting rates.

Bumpy Ride Ahead

Just as it looked as though there was some hope of stabilisation in global economic conditions, the September US ISM (Institute of Supply Management) Index released on Monday was not only weak but it was a lot worse than expected at 47.8 (below 50 means contraction).  Markets clearly took fright, with the sell off in stocks intensifying yesterday in the wake of the US ADP jobs report for September, which recorded an increase of 135k jobs by private sector employers, its weakest reading in three months.

This all sets up for a nervous wait ahead of tomorrow’s September jobs report in which markets will be on the look out for any slowing in nonfarm payrolls and/or increase in the unemployment rate.  The consensus expectation is for a 148k increase in payrolls in September and for the unemployment rate to remain at 3.7%, but risks of a weaker outcome have grown.  The US dollar has also come under pressure as US economic risks increase.

Rising geopolitical risks are adding to the market malaise, with the impeachment enquiry into President Trump intensifying and risks of a hard Brexit in the UK remaining elevated.  On the latte front UK Prime Minister Johnson published his plans for a Brexit strategy yesterday replacing Theresa May’s “backstop” plan with two new borders for Northern Ireland.

If the proposal isn’t agreed with the EU, there is a strong chance that Johnson will be forced to seek another extension to Article 50 from the end of October, prolonging the three and a half years of uncertainty that the UK has gone through.  GBP didn’t react much to the new plan, and surprisingly did not fall despite the sharp sell off in UK equities yesterday, with the FTSE falling by over 3%.

The fact that the US has now been given the green light to impose tariffs on EU goods after the EU lost a World Trade Organisation (WTO) ruling adds a further dimension to the trade war engulfing economies globally.  The US administration will now move ahead to impose 25% tariffs on a range of imports from the EU, with the tariffs implementation likely to compound global growth fears.  If the EU wins a similar case early next year, expect to see an onslaught of EU tariffs on EU imports of US goods.

This is taking place just as hopes of progress in trade talks between the US and China in talks scheduled for next week have grown.  But even these talks are unlikely to be smooth given the array of structural issues that remain unresolved including technology transfers, Chinese state subsidies, accusations of IP theft, etc.  Additionally, the fact that the US administration has reportedly discussed adding financial restrictions on Chinese access to US capital suggests another front in the trade way may be about to open up.

The bottom line is that there is a host of factors weighing on markets at present and adding to global uncertainty, none of which are likely to go away soon.  Now that fears about the US economy are also intensifying suggests that there is nowhere to hide in the current malaise, implying that risk assets are in for a bumpy ride in the weeks ahead while market volatility is likely to increase.

 

 

 

 

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