BMA Market Insights: RISK-OFF Weak Economic Data and Trade Concerns

The markets did an about-face last week, capping the week with a RISK-OFF sentiment. All three major U.S. stock indices closed in the red, dropping more than 2% over the five-day period. Increased volatility prompted gyrations in Treasury yields, with the 10-year Treasury hovering around 2.63% at the close. Weaker data both domestically and abroad coupled with jitters surrounding Chinese/U.S. trade negotiations fueled concerns regarding a global economic slowdown.

Domestically, headline U.S. February payrolls data came in much weaker-than-expected (see more below), further supporting the Federal Reserve’s patience stance towards its monetary policy. Despite the sharp slowdown, there were notable positive takeaways from the report, which included higher wages, greater labor participation, and upward revisions to payroll data for the past two months. The Fed’s next meeting is scheduled for March 19-20, where economic forecasts are expected to be shared and the impact of the aforementioned jobs report closely monitored. Prior to the meeting, the Fed will have a chance to digest key domestic data releases this week including retail sales, CPI and durable goods.

Outside of the U.S., disappointing economic data trickled in throughout the week. Chinese trade data spurred an equity selloff as the country’s exports in February shrank 20.7% y-o-y. China’s bilateral surplus, specifically with the U.S., came in at $14.72 billion, a two-year low. In regards to trade negotiations, little progress seemed to be made between the two countries. Officials from both sides signaled that an agreement is not imminent, with a date yet to be scheduled for President Xi and President Trump to meet. The potential summit between the country heads is largely meant to signify a deal.

The Bank of Canada, the Reserve Bank of Australia, and the European Central Bank unsurprisingly kept their respective key policy rates unchanged (see more below). The European Central Bank, however, surprised the market with its more dovish stance by presenting stimulative measures, signaling that rates would likely be on hold longer than previously anticipated and cutting growth forecasts.

Growth forecasts were also lowered by Chinese officials and by the OECD who revised down their global economic growth projections for 2019 and 2020.

This week all eyes are on market-moving retail sales and industrial production data, which are on the docket for the U.S. and certain key regions abroad. The Bank of Japan’s monetary policy decisions this week, though largely expected to keep rates steady, will keenly be monitored. We will be on the lookout for governor Kuroda’s post-meeting press conference for signs of possibly easing policy. Finally, the market will focus on the U.K. Parliament’s vote on Brexit and a possible extension as the March 29th divorce date nears.

I. U.S. Economic Data/Markets

February payrolls surprised to the downside with 20k jobs added versus expectations of 180k. The report noted that payroll numbers may have been distorted due to the government shutdown. Key takeaways included:
- Construction, mining, and retail saw job losses and the manufacturing sector added workers, albeit at a slower pace.
- February had the fewest number of jobs added in a given month since September 2017.
- Positive details of the report included:
  - Payroll data for both January and December were revised upward, with an average of 186k jobs added per month over the past three months.
  - Wages picked up about 3.4% y-o-y.
  - The unemployment rate fell to 3.8%, after edging higher (4% in January) during the partial government shutdown.
  - Labor-force remained at 63.2%, the highest since 2013.
Nonfarm Productivity increased by 1.9% annualized for the final quarter of 2018, reflecting the strongest nine-month stretch of growth between April and December since 2000, with an average of 2.2%. The fiscal tax cuts may have partly served as a boon to productivity.
- Analysts largely expected a 1.6% increase.
- Companies increased the number of services and goods for the quarter by 3.1%, while the hours’ workers spent on the job moved up by 1.2%.
- Higher productivity tends to keep inflation at bay and may bode well for ultimate GDP data.
Housing Starts jumped 18.6% in January, to a rate of 1.23 million units versus expectations of 1.197 million units.
- Single-family home building, which accounts for the largest share of the housing market, increased by 25.1%.
Federal Reserve removed certain qualitative test parameters for domestic banks per its 2019 stress tests, this included certain operational and risk management practices.
- On the flip side, officials are considering raising the standard under which non-bank financial firms such as insurance companies or asset managers operate, for stricter supervision.
Fed Official Williams noted that slower growth may be the “new normal” due to a declining workforce and lower gains in productivity – which then justified the current level of interest rates at “neutral.” Other takeaways included:
- A rate cut may be justified, despite a strong economy, if inflation continues to be benign.
- Fed would consider buying bonds and other assets in a weak economic scenario.
Markit Composite PMI Output index reflected a level of 55.5 in February, up from 54.4 in January.
- A pick-up in activity within the services sector offset a slowdown within manufacturing.
Factory Orders grew less-than-expected in December at 0.1% versus expectations of 0.5%.
Construction Spending dropped in December by 0.6% versus expectations of a 0.2% increase.
- November spending remained unchanged with a 0.8% increase.
Trade Balance deficit increased more than 12% y-o-y in 2018 to $621 billion.
- The surplus in services which rose to $270 billion was offset by a record deficit in goods of $891 billion.
- Construction spending was down in December.
- Macroeconomic factors contributed to the widening deficit, including:
  - The USD’s rally, which made U.S. import more expensive and thereby less demand for them.
  - Faster economic growth in the U.S. relative to its counterparts allowed for greater demand in the U.S. for imports versus goods exported.
Non-manufacturing ISM increased in February with a 59.7% reading relative to a 59.6% reading in January. All 18 sectors within the index reflected an increase.
- Concerns surrounding tariff uncertainty, capacity constraints and employment resources were cited by respondents, but who were generally optimistic about overall business conditions.
- It is the 109th consecutive monthly increase for the index.
New Home Sales hit a seven-month high in December, with an increase of 3.7% – a seasonally adjusted annual rate of 621k units. Analysts largely expected a drop in sales of about 600k units.

II. Other

China/U.S. Trade talks – While broad outline of an agreement have surfaced (e.g. with China buying more American goods and further opening its markets to foreign goods), challenges remain, including mechanisms in enforcing the agreement.
- Doubts have emerged whether President Xi and President Trump will meet in late March or early April.
- Possible further discussions between both sides will occur after China’s National People’s Congress which ends on March 15th.
Chinese Economics
- China lowered its 2019 economic growth target to between 6% and 6.5%, from 6.5% to 7%, on the back of an economic slowdown in part due to higher debt levels and uncertainty surrounding trade.
- Chinese officials noted providing stimulus measures to help boost domestic consumption. The government plans to increase infrastructure spending and implement tax cuts to help boost the economy.
- Trade data dropped to $4.12 billion in February, a steep drop for January’s surplus of $39.16 billion. The Chinese New Year holiday in part contributed to the data.
  - Exports tumbled 20.7% from a year earlier after increasing 9.1% in January.
  - China’s bilateral trade surplus with the U.S. dropped to $14.72 billion, a two-year low.
The Organization for Economic Co-Operation & Development cut its 2019 and 2020 global forecasts, again.
- The OECD projected global growth forecasts was 3.3% and 3.4% for 2019 and 2020 respectively. Last November the OECD projected 3.5% growth for both 2019 and 2020.
While the European Central Bank, kept rates on hold, it presented the policy measures to stimulate the EU’s slowing economy. The interest rate on refinancing operations remained at 0.00 %, with the rates on the marginal lending facility and deposit facility held at 0.25% and -0.40% respectively.
- The bank would keep rates on hold at least until the end of the year versus previously signaling that rates would stand pat until the fall of 2019.
- The ECB also announced long-term cheap loans for the banks, to be launched in September with two-year maturities, to help stimulate growth.
  - Cheap funding enables banks to provide more favorable terms to borrowers.
  - This is the third time the ECB has employed this mechanism to stimulate the economy.
- ECB also planned to reinvest principal payments from maturing securities purchased under the asset-purchase program for an extended period of time to maintain favorable liquidity conditions.
- ECB lowered its growth estimates for 2019 to 1.1% from 1.7% in December.
  - Political developments in Italy, Brexit, trade concerns with the U.S. and a slowdown in the Chinese economy have all weighed on the EU’s economy. Recent data illustrated that the economy grew at its slowest pace in four years in the final quarter of 2018 where GDP increased by 0.2% q-o-q.
  - The Euro fell to levels last seen in 2017 on the back of the announcement.
Bank of Canada held rates steady at 1.75% and noted increased uncertainty regarding future rate hikes.
- The bank’s economic outlook weakened for the first half of 2019 relative to its projections in January. Key areas monitored by the bank included: oil prices, housing market, and global trade developments.
Canada Manufacturing PMI dropped to a 26-month low, to 52.6 in February in part due to softer job growth and stagnating pre-production inventories.
Bank of England Gov. Carney noted that the U.K. was better prepared for a no-deal Brexit with officials have taken measures to reduce financial risks and minimize trade frictions, although Carney expressed there still would be a measurable economic impact of the UK leaving the EU.
- A disorderly Brexit could lead to GDP dropping 8%, housing prices falling 30% and unemployment rising to 7.5%.
- Carney also noted that the current implied path of rates was not high enough, particularly given that inflation will likely be above the bank’s target and that the economy will likely be growing above trend with full employment.
Reserve Bank of Australia kept the key rate unchanged at 1.5%.
- Officials shifted their tone to a neutral stance with an equal probability of rates moving up or down going forward, while previously it was leaning towards higher rates.
- Declines in housing prices, weak consumer sentiment, and wage growth contributed to the less hawkish sentiment.
- The bank still expected that the economy will grow around 3% this year on the back of rising business investment, higher levels of spending on public infrastructure and increased employment.
U.K. Retail sales dropped 1.6% y-o-y in February, partly due to Brexit uncertainty.