Resist the Recession Hype

Last Week: Interest rates fell amid muted developments in global trade talks and Brexit negotiations as a strong start to the Q3 corporate earnings season lifted equity markets slightly. The yield on the 10-year US Treasury note was up only a basis point as compared with last week, to 1.74%. 1-month LIBOR offered a little more action, falling 5 basis points to 1.85%. Treasury yield volatility finished the week about where it started at 5.30. Crude oil dropped slightly to $53.91 per barrel as the US Dollar and Gold both weakened slightly.

Turns out the “Phase 1” US-China trade deal is farther off than once thought. China announced that it wants another round of talks before signing what President Trump called “Phase 1” of a trade deal between the two nations. While details of China’s ask for more talks are unclear, the word on the street is that they’ll likely happen before the end of the month. Beijing wants a rollback in US tariffs before it will agree to binge on $50 billion in US agricultural products that President Trump claims are part of an initial deal. A tariff hike implemented by the US in September was not rolled back and plans for another hike just before the Christmas holiday on December 15th remain in place. China’s request for more talks tells us that Washington and Beijing are miles apart from establishing a broad ranging trade agreement, despite what was recently touted by the President last week. That means the US-China trade war will be with us for months to come and will continue to be a drag on rates moving appreciably higher anytime soon, as businesses become increasingly wary of making large capital expenditures.

As we await clarifying details to the “Phase 1” US-China trade deal, China reported GDP growth of 6% in Q3, its slowest expansion since 1992. Sure, China’s slowing growth offers needed leverage for the US in the trade negotiations, but it also means that China is buying less from the rest of the world, pushing its trade surplus higher and dragging down global economic growth.

US retail sales data, an important gauge of the consumer’s resilience in driving US economic growth, disappointed in September, falling for the first time in seven months. Headline retail sales fell 0.3% in September, significantly below the consensus estimate, which called for a 0.3% increase. This was the lowest reading since February of this year. However, the almighty US consumer hasn’t cracked – yet. Last week’s weak data follows solid and upwardly revised retail sales activity in August (0.6% vs. previously estimated 0.4%) and strong readings over the prior months. At the end of the day, last week’s weaker-than-expected data solidifies the need for the Fed to cut the target rate by 0.25% at the end of this month, as it follows a series of deteriorating economic statistics since the September Fed meeting, and upholds our expectation of slower US economic growth, and lower rates, into year-end. How can you capitalize on this new world of even lower rates? It may call for a more creative solution other than plain ‘ol rate caps and swaps. Ask us how…

Your (and our) love of French wine and Scotch whisky just got more expensive. The Trump administration imposed 25% tariffs on European Union (EU) goods including French wine, Italian cheese and single malt whisky in retaliation for EU subsidies on large aircraft. We don’t know about you, but America’s multi-front trade wars are getting real for us now.

A BREXIT Deal? As we’ve mentioned repeatedly in previous newsletters, we’ll spare you the back and forth minutia of BREXIT. When something real happens, and there’s a breakthrough in the UK’s divorce from Europe that will affect US interest rates, we’ll let you know. Until then, you’re welcome.

IMF cut its global growth forecast – again. The International Monetary Fund warned that the US-China trade war could cause 2019 global growth to fall to its slowest pace since the financial crisis, and that the outlook could darken further if trade tensions remain unresolved. The World Economic Outlook report details economic difficulties caused by US–China tariffs, including direct costs, market turmoil, reduced investment, and lower productivity due to supply chain disruptions. The IMF’s latest projections are for 2019 GDP growth of 3.0%, down from 3.2% in July. Compounding the gloom, Germany, Europe’s largest economy, lowered its growth forecast to expand by just 1% next year, compared with an earlier expectation of a 1.5% increase. That will keep German bond yields low, which will serve as an added drag on US interest rates as well. With rates globally set to stay low and even move lower, and Central Banks’ tools becoming increasingly blunted in their effectiveness to thwart slower growth, perhaps it’s time to look to fiscal policy – via our politicians – to step up and bridge the gap.

What to Watch This Week: With the Fed entering its pre-meeting blackout and a light data calendar, markets will focus elsewhere for direction in the days ahead. Simmering trade tensions, Brexit progress, elevating geopolitical tensions, corporate earnings, and domestic politics should offer plenty of excitement regardless.

The main event on the data docket will be September durable goods orders (think the number of new orders placed with US manufacturers for washing machines, computer equipment, industrial machinery, etc.) Results are expected to be soft, reflecting slowing global growth and growing hesitation by businesses in making sizable capital expenditures as a direct result of the multi-front US trade wars. A weak showing in the data will add downward pressure to US Treasury yields.

Take-Away: Since the September Fed meeting, economic data have signaled slowing US economic momentum. The latest report on retail sales dovetailed with a decline in capital goods orders and manufacturing and services gauges, a deceleration in hiring momentum and a drop in consumer inflation expectations to multi-decade lows. Since its clear things are slowing, will the US tip into recession in the coming quarters?

No. Firstly, the Fed’s turn toward cutting rates and an expectation of further rate cuts in the near future should more than offset the gloom. Secondly, given that America’s multi-front trade war is at least partly responsible for the slowing economy, a substantial escalation of such would be required to stomp on growth even further and kick the economy into recession. It’s highly unlikely given that the White House will seek to avoid any major economic disruption ahead of the election and will simply back off if things get ugly. Trade tensions, the path of monetary policy, and global growth concerns will continue to keep yields under pressure through year end.