BMA Market Insights: Fed Speak, Brexit Vote, and the U.S. Government Shutdown in Focus

Cautious sentiments emanated from Federal Reserve officials last week, with the latest FOMC minutes also reflecting a more wary tone on the backdrop of a slowing global economy, particularly in China and trade concerns. Three of the four new voting members within the FOMC spoke last week, with two outspoken “hawks,” Eric Rosengren and Charles Evans, emphasizing patience, and the need for greater clarity surrounding the economic outlook in order to determine monetary policy going forward (see more below).

The Fed’s consistent message that it will adjust its policy as needed, supported the stock market last week. Further, potential progress surrounding Sino-U.S. trade talks served as a boon to global equity markets and oil prices. Both sides appeared to be more optimistic regarding a trade resolution, although details regarding the discussion remained unclear. All three major U.S. equity indices closed the week higher, the third consecutive week of gains. Conversely, Treasury yields dipped on the back of the Fed’s rhetoric, in particular, Chairman Powell’s comments and on weaker-than-expected U.S. inflation data released towards the end of the week. The 10-year Treasury hovered near 2.702% at the time of this writing.

Oil prices gained last week and had nine straight sessions of increases until Friday – the longest positive run in about a decade. Crude prices were about 8% higher over the week, trading around $51.59/barrel on the back of Iran sanctions, less robust U.S. oil supply and OPEC supply cutbacks. 

All eyes will be across the pond this week when the U.K. Parliament votes on PM Theresa May’s Brexit proposal tomorrow. As the proposal is largely expected to be voted down, May will have only three days to propose an alternative plan.

Before the Brexit vote, close attention will be paid to trade data out of China on Monday. Further, inflation data will be released throughout the week from key economies including the: U.S., EU, Japan, Canada and the U.K. Back at home, U.S. December retail sales (given consumption impact on overall economic growth), Philadelphia Fed Manufacturing Survey, Housing Starts and Building Permits will be closely watched (see more below).

Outside of the aforementioned events and economic data to be released, the markets will focus on 1) any developments regarding the U.S. partial government shutdown and 2) Q4 2018 earnings announcements starting this week with Wall Street juggernauts like J.P. Morgan and Citigroup to kick things off.

I. U.S. Economic Data/Markets

• Consumer Price Index contracted by 0.1% in December with core CPI (excluding food and energy) rose 0.2%. While the data met expectations, the drop in the headline inflation figure prompted a drop in Treasury yields, with the 10-year falling almost three basis points to 2.70% on the back of the news.
  • If inflation is not rising and thereby not deterring growth prospects, it may give the Fed greater latitude to be patient regarding tightening monetary policy.
• ISM non-manufacturing for December came in lower-than-expected at 57.6 versus expectations of 59. It is the lowest reading since July, which had a reading of 55.7.
  • A drop in prices within the services sector last month may have contributed to the weaker data.
• Key takeaways from various Fed Officials speeches:
  • Fed Chairman Powell stressed the bank’s patience and flexibility regarding its monetary policy. He re-emphasized that the Fed is not on a preset plan and that Fed’s current forecast of two rates hikes in 2019 was predicated on a strong outlook for the year.
    • Powell also noted the Fed’s intent to have a smaller balance sheet with a gradual runoff of assets.
  • Official James Bullard (voting member) reiterated his dovish stance that the Fed should hit the pause button regarding rate hikes. While not a voting member in December he expressed then against the rate hike.
    • Bullard also noted that shrinking the balance sheet would not be as damaging to the markets as other market practitioners might have suggested, particularly as rates have moved lower since November.
  • Official Eric Rosengren (voting member) voiced his patience regarding rate hikes to see how the economy performs. Rosengren believed that consumption will fuel growth and tighten labor markets in 2019 and that the markets are overly pessimistic. He noted, however, that the risk of a U.S. economic slowdown led by weakness abroad had increased given recent data regarding China’s economy and the potential for trade tensions.
  • Official Charles Evans (voting member) noted that the uncertain economic outlook and benign inflation has given the Fed reason to pause raising rates. Fiscal headwinds, trade, uncertainty regarding growth abroad were among the downside economic risks he noted. Nonetheless, if fundamentals remain strong and risks dissipate, Evans could see the Fed funds rate come to 3-3.25%.
    • If the economy performs as he expects in 2019, Evans is calling for three rate hikes this year and none for 2020.
• Key takeaways from the FOMC December Minutes meeting included:
  • While December’s rate hike was unanimous, going forward, the Fed could “afford to be patient about further policy firming” and more cautious, in part given low inflation levels.
  • Trade tensions, global growth prospects and the sustainability of corporate earnings growth were among the concerns cited attributing the drop in U.S. stock markets.
  • Officials seemed to be leaning towards removing future forward guidance, emphasizing policy is not a preset course and largely impacted by data.
  • The yield curve steepened on the back of the minutes being released.
  • The next FOMC meeting will be on January 29th-30th.

II. Other

• China/U.S. Trade Talks
  • Talks were extended to an unscheduled third day last week, which led the markets largely hopeful that a trade resolution will come to fruition. Stock markets globally rose on the back of the talks.
  • Following the discussion, Chinese officials noted that both sides established a foundation to ultimately find a resolution. Similarly, U.S. officials noted progress regarding the negotiations with China agreeing to buy a number of goods and services from the U.S., which included agricultural, energy and manufactured goods.
• Brexit: U.K. Parliament votes on PM Theresa May’s Brexit proposal tomorrow. If the measure is not passed, the government will then have three days to file a motion detailing how they plan to proceed.
  • Parliament passed two measures last week adding pressure on May: 1) limiting the time from 21 days to three days that May has to get back to Parliament if her proposal is not approved by Parliament, and 2) amending a Finance Bill that would prohibit government spending in a “no-Brexit” – essentially making it harder for the U.K. to leave the EU without a deal, given the financial consequences of a no-deal Brexit.
  • Prospects of a second referendum seem to be gaining more traction, a second referendum would likely occur after the deadline of March 29th (when the U.K. is scheduled to “exit” the EU), which would then require the approval of the EU countries agreeing to an extension beyond March 29th.
• Bank of Canada voted to keep its key rate unchanged at 1.75%. The next meeting is scheduled for March 6th.
  • Moderating global growth (including U.S./China trade concerns), weaker oil prices a slowdown in consumption and housing investment were among the concerns cited by the BoC.
  • The bank lowered its 2019 GDP growth outlook to 1.7%, 0.4% slower than its forecast in October.
  • BoC Gov. Poloz acknowledged that the economy is running at about 90% of capacity and that tight labor conditions may pose growth challenges at the post-meeting press conference.
    • The Key data/events this week: impact of the decline in oil prices was at the “heart” of the announcement and considered ”a setback, a delay.”
• China’s December y-oy PPI and CPI came in less-than-expected. PPI resulted in a 0.9% increase (versus expectations of 1.6%), the lowest growth rate in two years. Similarly, the CPI disappointed by rising by 1.9% versus estimates of 2.1%. Falling inflation suggested that the economy may be slowing down, which could pressure the central bank to cut rates.

Key data/events this week:

• CNY trade data (Monday)
• CNY foreign direct investment
• EUR industrial production
• UK Parliament votes on Brexit (Tuesday)
• French CPI
• U.S. PPI
• JPY Machine Orders
• German CPI data (Wednesday)
• U.K. retail price index/PPI/CPI
• U.S. retail sales
• U.S. Fed Beige Book
• AUD consumer confidence
• AUD housing data (Thursday)
• EUR inflation data
• U.S. Housing Starts
• U.S. Building Permits
• U.S. Philadelphia Fed Manufacturing Survey
• JPY CPI
• JPY industrial production (Friday)
• CAD CPI
• U.S. capacity utilization
• U.S. industrial production
• U.S. Michigan Consumer Sentiment Index