BMA Market Insights: RISK-ON, Global Markets Rally After U.S.-China Ceasefire

The Dow, S&P 500, and Nasdaq futures surged overnight after an agreement to a ceasefire in the U.S.-China trade war. The big news in the oil markets overnight is the announcement by Qatar to withdraw from OPEC and focus on its leadership in the liquified natural gas (LNG) arena. WTI crude oil trading at $53.075/bbl (+4.22%). The 10-year U.S. Treasuries are trading +2.9bps at 3.034%. 10-year USD Swaps are trading +4.9bps higher at 3.108% as of this writing.

Equity markets were resuscitated mid-last week with FOMC Chairman Powell’s speech tempering investor expectations over its rate hike policy coupled with the market’s optimism on the trade outlook between China and the U.S., ahead of Presidents Xi’s and Trump’s meeting over the weekend. The S&P 500, up nearly 5%, posted its biggest weekly gain since 2011. Treasury rates fell, with the ten-year Treasury yield closing the week at 3.005%.

Despite the markets largely perceiving Powell’s comments as dovish (see more below) the Chairman did note that “interest rates are still low by historical standards.” Powell also emphasized that the recent volatility seen by the equity markets did not pose a threat to financial stability, reinforcing the idea that recent stock market moves would not influence the Fed. The idea that monetary policy is not pre-set, and economic data remains key in impacting the policy, was reiterated in the FOMC minutes from the November 7th and 8th meeting, also released midweek.

Given this focus on data, all eyes will be on the U.S. November jobs data to be released on Friday at 8:30AM EST. A strong headline number will reinforce the highly anticipated Fed rate hike at the December 16th and 17th meeting and perhaps influence economic projections to be released then. Given the recent slowdown in economic confidence and growth, particularly outside of the U.S. (see more below), third quarter GDP data out of the Eurozone, to be released at the end of the week, will also be carefully monitored.

Both the Central Bank of Canada and the Reserve Bank of Australia meet this week, with the widely held expectation that both central banks will keep their key rate unchanged at 1.75% and 1.50% respectively. For the Canadians, while inflation has been on the rise, the recent decline in oil prices (one of the country’s major exports) counters any upward pressure on inflation. Conversely, a decline in oil prices should have a positive impact on the Australian economy, given it is a net importer of the commodity. The RBA is still expected to keep rates on hold on the back of a mixed economic backdrop of a weakening housing sector, wages in line with expectations and solid employment.

I. U.S. Economic Data/Markets

Third quarter GDP increased 3.5%, unchanged from estimates in October, beating analyst forecasts of 2%.
- Fiscal cuts largely attributed to consumer spending and business investment.
- Second quarter GDP came in at 4.2%.
Core Personal Consumption Expenditures price index surprised to the downside rising 1.8% in October y-o-y versus expectations of 1.9%. This is the Fed’s preferred measure of inflation.
- A stronger USD making imports relatively cheaper partly attributed to the lower inflation.
Fed officials largely felt that another rate hike was warranted fairly soon based on the FOMC minutes from the Nov. 6th and 7th meeting. Other key takeaways included:
- Officials expected gradual rate increases given strong economic activity, given low unemployment and inflation hovering the committee’s 2% objective.
- An emphasis was placed on how monetary policy is not on a pre-set path and that the committee is focused on incoming economic data/conditions.
  - The recent tightening of financial conditions, risks in the global outlook and signs of slowing in interest-sensitive sectors of the economy were among areas the FOMC is monitoring.
- Participants commented on how the Committee’s communications in its post-meeting statement may need to be revised, in particular, the language referring to the committee’s expectations for “further gradual increases” in the target range for the federal funds rate.
  - Discussions around transitioning the post-meeting statement language that would place greater emphasis on the evaluation of incoming data in assessing the economic and policy outlook and would low for a more flexible approach in responding to changing economic circumstances.
October new home sales dropped to a multi-year low, falling nearly 9%. Data surprised to the downside as the market largely expected an increase in sales by 3.7%.
- Sales fell 8.9% last month to an annual rate of 544k units, the lowest level since March 2016.
Housing price gains fell to the lowest level since January 2017.
- The S&P Case-Shiller index housing prices increasing 5.5% annually in September, a drop from 5.7% in August.
- Higher mortgage rates in part contributed to the drop, the average 30-year fixed rate mortgage is around 4.9%, about a percentage point higher from a year ago.
Pending Home Sales dropped 6.7% m-o-m in October, the tenth straight month of declines.
- A combination of higher mortgage rates and tighter housing inventory (thereby driving up prices) contributed to the data.
Fed Chairman Jerome Powell noted interest rates are just below the neutral level at a speech on Financial Stability last week. Neutral is considered the level of rates designed to neither ignite nor slow growth. Equity markets rallied (i.e. the Dow Jones moved up about 2%) on the back of Powell’s perceived dovish comments, particularly since the Chairman stated that rates were far from neutral in October. Other key takeaways included:
- Powell did note rates remain at historically low levels.
- Recent swings within equities did not pose as a risk to financial stability, signaling the declines would not deter the Fed from raising rates.
- Economic effects of gradual rate increases are uncertain and may take a year or more to be fully realized.
- Asset classes where valuations seem high on a historic basis included commercial real estate and riskier classes of corporate debt.
- The unsettled state of trade negotiations, Brexit, budget talks between Italy and EU were among the potential triggers that could cause financially distressed.
- Inflation seemed contained while the economy was on solid footing.

II. Trade

Canada, Mexico, and the U.S. ceremoniously signed the revised version of North American Free Trade Agreement (“NAFTA”) at the G20 Summit, which will now be called U.S.M.C.A. However, each country’s respective legislature still must approve the deal.
- President Trump said he plans to terminate the existing NAFTA agreement, which would then give Congress six months to ratify the revised agreement.
China/U.S. Presidents Xi and Trump called a ceasefire for 90 days on imposing further trade tariffs on each others’ goods at the G20 Summit.
- Prior the summit, the U.S. announced that it planned to increase tariffs on $200 billion of Chinese goods from currently 10% to 25% effective on January 1st. The new agreement keeps the tariffs at 10% for at least 90 days so the two countries can further negotiate a deal.
- China also agreed to buy more agricultural products from the U.S. although details remain unclear.

III. Other

At a meeting with the European Parliament, ECB President Draghi defended the bank’s stance of phasing out of its EUR 2.6 trillion bond-buying, QE, program in December, despite recent soft economic data stemming from the EU.
- Draghi noted that weaker recent economic data is temporary and that the EU has been coming off strong growth rates and the economy is still strong by historical standards.
- Any decision will be formalized at the ECB’s next meeting on December 13th.
Eurozone inflation slowed in November, rising 2% y-o-y versus October’s reading of 2.2% y-o-y.
German business confidence falls for the third consecutive month. The IFO Business Climate index, a key survey measuring business sentiment fell to 102 in November from 102.9 in October.
- New emission standard for the German auto sector partly contributed to the decline.
- Concerns regarding geopolitical risks remain elevated as uncertainty among businesses rose to its highest level in 10 years.
Canada’s economy grew at 2% annualized last quarter, coming in line with expectations.
- 3Q data dropped from the 2.9% annualized expansion in the second quarter.
- Weak business investment coupled with declines in oil impacted the data.
Italy’s 3Q GDP contracted by 0.1%, largely due to weaker domestic demand. It is the first time GDP declined since 2Q 2014.
China’s services PMI slowed for a second consecutive month coming falling to 53.4 from 53.9 in October. Waning consumer demand and confidence likely contributed to the data. The services sector accounts for more than half of the Chinese economy.