Since the beginning of October, US equity indexes have experienced elevated volatility and have fallen in and out of correction territory. Concerns over a flattening/inverted yield curve as well as the prospect for slower global growth have ruffled the markets. As a result, market participants have scaled back their risk positions and repriced the Fed's rate path in 2019, with some even going as far as saying the Fed won't raise in December. But in my view, the recent stock market volatility should not hold the Fed back in December.
Although the stock market gets a lot of press, it is important to remember that it isn't the economy. Since the trough in 2009, the S&P 500 has risen nearly 300%, while the real economy has risen only 44%.
This disconnection is partially explained by the distribution of income during the recovery. Corporate prices have rebounded strongly, but wages have grown at a much slower rate. With wages on the rise, corporate earnings forecasts have been revised down, leading to choppy equity markets. However, higher wages imply a robust household sector which should support the economy.
With regards to the yield curve, history has shown that the yield curve has inverted before most recessions. But since 1954, the average number of months between inversion and recession is 27 months, with the range going from 9 to 66 months. So an inverted curve means that a recession could happen sometime in the next 5 years, which isn't very instructive. Lastly, there are questions around whether or not the yield curve signal is less reliable than in the past due to QE which has depressed term premium.
The concern, however, is the negative sentiment spillover with stock market pain and concerns over the yield curve spilling over to Main Street confidence. To this point, so far Google trends have shown only a modest increase in yield curve and recession searches.
MAJOR CENTRAL BANK ACTIVITY THIS WEEK
Expectations for rates to remain unchanged at 6.50%
Expectations for rates to remain unchanged at 4.75%
Expectations for rates to remain unchanged at -0.75%
Expectations for rates to remain unchanged at 0.00%
Expectations for rates to remain unchanged at 7.50%
KEY MARKET MOVING ECONOMIC RELEASES
United States and Canada
Expectations for a 0.0% print; YoY drops to 2.5%
Expectations for a 0.0% print: YoY drops to 2.2%
Expectations for a gain of 0.2% following a 0.8% gain
Expectations for a gain of 0.3% after a 0.1% gain
EZ Composite PMI
Expectations for a sharp decline from 58.2 to 55.3
German ZEW Survey
Expectations for a final print of 0.6%; 2.7% YoY
Expectations for a gain of 0.1%; YoY remains at 2.3%
U.K. Trade Report
Expectations for another large trade deficit
U.K. Industrial Prod.
Expectations for a print of 0.0%
U.K. Jobs Report
Expectations for the UR to remain at 4.1%
Asia/Japan, and New Zealand
Retail sales, industrial production, etc.
Expectations for a print of -0.1%; YoY drops to 2.4%
Tankan Large Manuf.
Expectations for a slight drop in the index from 19 to 18
The EUR, like the US dollar, remains trapped within a narrow and volatile range. Sharp and rapid changes in equities, interest rates, and commodity prices have had little impact so far on any clear directional change in foreign exchange rates. European politics concerning future German leadership, Brexit, and Italian budgetary issues are all near term negatives set against dramatic changes in the US yield curve and Fed expectations. Expect more short term volatility next week.
The GBP has displayed extreme volatility over the past two weeks with wide ranges but little to show for all the price action. The GBP remains pinned down near yearly lows as the trials and tribulations of the upcoming Brexit vote in Parliament this week and PM May’s standing all offer uncertain outcomes. Expect another wild and wooly week ahead.
The JPY is one of the top performing major currencies this past week and month as a combination of US equity fallout and the flattening and inverting of the US yield curve have squeezed JPY short positions. That being said, the JPY has only appreciated by 0.79% against the US dollar over the past month. Continue to expect the JPY to have an inverse relationship with risk sentiment.
The CAD has been in a short term bear trend since oil prices peaked at the beginning of October; the CAD has fallen by 3.67% and the Mexican peso by 7.50% since October 1. This is despite a Bank of Canada rate increase in October and a great Canadian jobs report on Friday. Market psychology continues to be short term negative; many forecasters remain bullish over the medium term.
The CNY rallied early last week after the G20 summit and brief relief rally regarding the détente between US and China over trade. However, the CNY has given back much of those gains as a lack of specifics from China and the White House’s vague and inconsistent statements have hurt sentiment. The currency remains trapped within recent ranges – expect more of the same this week.
The AUD continues to remain range bound and continues to hover near its yearly lows. This past week, the AUD has been particularly weak losing 1.40% of its value against the US dollar as continued concerns about trade and weak commodity prices have hurt sentiment. Overall, it appears the currency is trying to bottom but expect more sideways trading this week.
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