BMA Market Insights: Trade Uncertainty Lingers, Bank of Canada Takes Center Stage

Global markets continuing a RISK-OFF sentiment this morning as elevated China-U.S. trade tensions continue to weigh on markets putting downwards pressure on equities and rates. 10-year U.S. Treasuries are trading 2bps lower to 2.295% this morning, levels last seen in October 2017.

This week, investors will focus on key PMI manufacturing data out of China, scheduled for Friday. Major U.S economic releases include the second reading of first-quarter U.S. GDP, consumer confidence, and the Personal Consumption Expenditure index, the Federal Reserve’s preferred measure of inflation.

Inflation continued to confound the Fed, as it remains stubbornly low. Last week’s release of the FOMC Minutes from the April 30th-May 1st meeting indicated the belief that the current low level of inflation is transitory. However, the minutes reflected concerns over low levels of inflation lingering longer-than-expected. In various speeches last week, Fed Officials also expressed the potential economic challenges with a prolonged period of low inflation and a protracted trade dispute (see more below).

The potential for a long-term trade spat was augmented when President Trump unveiled a $16 billion bailout for U.S. farmers hurt by the trade war late last week. There have also been reports that the Trump Administration is mulling blacklisting other Chinese companies, similar to its ban on Huawei Technologies. Trade jitters spooked the technology sector, evidenced by the near 20% decline of the Philadelphia semiconductor index over the last month.

Also in flux, is the economic future of the U.K. as Brexit uncertainty weighs on the markets. Last week, U.K. PM Theresa May offered her resignation effective June 7th. Market practitioners increasingly believe that a “no-deal” Brexit may come to fruition, particularly since many European governments, including France and Ireland, have insisted there is no room for further negotiations. The Conservative Party’s frontrunner to take the reins from May, Boris Johnson, noted on Friday that the U.K. would leave the EU on the October 31st deadline “deal or no deal”.

Outside of trade, the Bank of Canada will take the spotlight mid-week. The market largely believes the BoC will hold rates steady at 1.75% at its May 29th meeting. At its previous policy meeting, the bank cut its forecasts for short-term growth but expected an economic upswing in the second half of the year.  An increase in Canada’s economic activity, however, may be thwarted by any negative economic repercussions the U.S. may encounter in a long-term trade dispute, given the U.S. is Canada’s largest trading partner.

Last week, trade jitters drove all three major U.S. stock indices to the red, with the S&P 500 closing the week off at 2,826.06. Ten-year Treasury yields recovered a few basis points on Friday after hitting lows not seen since 2017 earlier in the week. The bounce on Friday led the 10-year Treasury to close the week at around 2.324%. Finally, concerns over an economic slowdown pressured oil prices lower, with U.S. crude suffering its biggest one-week loss in 2019, despite gaining 1.2% on Friday. WTI crude ended the week around $58.63/barrel.

Monday was a light trading day on the back of both the U.S. Memorial Day and the U.K. Spring Bank holidays.

I.   U.S. Economic Data/Markets

• New orders for capital goods declined-more-than-expected in April at  -0.9% compared to forecasts of -0.3%. The drop indicates to perhaps a slowdown in manufacturing and the broader economy.
• Durable Goods dropped 2.1% in April close to expectations of a 2% decline.
• Manufacturing PMI dropped to 50.6 from 52.6 in April, reflecting the lowest level since September 2009. The manufacturing sector accounts for about 12% of the economy.
• New Home Sales in April declined 6.9% to a seasonally adjusted annual rate of 673,000 units after March reflected a rate of 723k units.
• FOMC Minutes from the April 30-May 1 policy meeting indicated sentiment that low levels of inflation will likely be temporary, although the potential of low levels of inflation lingering longer-than-expected was discussed. Other takeaways from the meeting included:
  • Risks that inflation could be anchored below the Fed’s 2% objective if inflation does not rise over the coming quarters. Two officials expressed potentially cutting rates from current levels idf lower levels of inflation persist.
  • The duration of the Fed’s roughly $4 trillion portfolios was also in focus. Officials debated whether the portfolio should comprise of existing holdings of U.S. Treasuries, or be focused on shorter-term maturities. Some officials appeared to favor holding shorter-term maturities that could be swapped for longer-term securities in times of financial distress as a way to stimulate the economy.
• Fed Official Bullard expressed continued weakness in inflation, may prompt the Fed to cut rates. However, policy adjustments would be made according to incoming data.
  • Remained optimistic regarding the economic outlook and expected trade agreements will be reached in the near-term.
  • Prolonged trade dispute coupled with low inflation may force the Fed to “tread carefully in order to sustain the economic expansion.”
• Fed Official Rosengren indicated prolonged tariffs could prompt inflation to reach the Fed’s 2% target
  • Believed the Fed has no imminent need to change current monetary policy.
  • Provided a relatively upbeat outlook on the U.S. economy, outside of trade tensions with China. However, the uncertainty regarding the trade dispute calls for a more patient Fed.
  • Noted the potential challenge to distinguish the impact of tariffs on inflation in a tight labor market.
• April Existing Home Sales fell short of the markets’ expectations falling 0.4% m-o-m versus forecasts of a 2.7% rise. Housing supply remained tight on the back of land and labor shortages.
• FOMC Chair Powell noted while the growing levels of corporate debt can pose a threat to the stability of the financial system, current levels of borrowing are not in line with subprime mortgage levels that caused the last financial crisis. Further, the current low levels of rates reflect low-interest costs.
  • If economic and financial conditions were to deteriorate, highly leveraged companies could be more vulnerable and could amplify the downturn. Layoffs would likely increase and business spending would likely be cut back.
  • Noted regulators need to focus on improving  the monitoring of financial risk-taking.

II.  Trade

• China/U.S. trade tensions remained elevated as Treasury Secretary Mnuchin mid-week noted that the next round of discussions between both sides is at least a month away. Both President Trump and Chinese President Xi are expected to meet next month in Japan for the G20 Summit.
• Brexit – PM Theresa May offered her resignation as of June 7th. Former Foreign Minister, Boris Johnson is considered one of the frontrunners to succeed May. The GBP rallied on the back of May’s resignation and traded around $1.2713, the biggest gain on Friday in nearly three weeks.
  • Earlier in the week, May tried to sweeten her Brexit proposal, which has been rejected by three times, by telling Parliament Officials they will have a chance for a second referendum if they back her Brexit proposal to be voted on in early June. Other elements of her proposed plan included:
    • A legal obligation for the UK to come up with an alternative to the Northern Ireland backstop by the end of 2020.
    • Guarantees on workers’ rights and environmental protection.

III.  Non-U.S. Economics

• Eurozone Economy
  • The results of the EU Parliament elections slightly surprised the markets as more centrists gained seats with a record turnout of voters showing up to the polls. Both stocks and the Euro rallied on the back of the results.
  • ECB President Draghi emphasized the need for the bloc to have a more solidified banking union, via deeper fiscal coordination.
    • There need to be elements of risk sharing among the EU, with the private sector taking precedence over increasing public risk-sharing.
  • Eurozone Manufacturing PMI dropped to a two-month low of 47.7.
  • German Q1 GDP came in-line with expectations at 0.4%. Household spending rose at its strongest pace in eight years.
  • German IFO Business Climate data fell to the lowest reading since November 2014, coming in at 97.9 in May versus expectations of 99.1.
  • German Markit PMI Manufacturing dropped to 44.3 from 44.4 in April, the fifth consecutive monthly reading below the 50, reflecting a contraction within the sector. Services PMI also declined to 55 from 55.7 from the previous month.
• U.K. Economy
  • CPI rose to 2.1% in April, up from 1.9% in March, largely driven by higher energy prices. Higher airfare prices, up about 26.4% on the month, also contributed to the data.
    • Core inflation, excluding food and energy, declined to 1.8% from 1.9% in March.
  • Retail Price Index increased to 3.0% in April from 2.4% in March.
  • Retail Sales surprised to the upside rising 5.2% y-o-y in April versus expectations of a 4.6% rise, largely driven by online purchases.
• Canadian Economy
  • Retail Sales slightly surprised to the upside in March coming in at 1.1% versus expectations of 1.0%. Higher sales related to energy, building materials, and gardening equipment drove the data.
• Japanese Economy
  • Trade surplus sharply declined in April, about $550 million or 90%, largely due to a drop in chip-related products to China. Exports contracted for the fifth consecutive month.
    • The trade surplus with the U.S. was up for a second consecutive month, given exports of automobiles, chip-making equipment, and aircraft.

Key data/events this week:

• BoJ Gov. Kuroda speaks (Monday)
• JPY Leading Economic Indicators/Retail Sales
• German Confidence Survey
• EU Business Climate (Tuesday)
• U.S. Consumer Confidence
• U.S. S&P/Case-Shiller Home Price Index
• German Unemployment (Wednesday)
• Bank of Canada Rate Decision
• Richmond Fed Manufacturing Index
• Fed Beige Book
• U.S. GDP/Personal Consumption Expenditures (Q1)/Pending Home Sales (Thursday)
• JPY CPI/Unemployment/Industrial Production/Retail Trade
• CNY Non-manufacturing PMI/NBS manufacturing PMI (Friday)
• German Retail Sales/CPI
• U.S. Personal Consumption Expenditures (m-o-m)/Personal Income
• CAD GDP
• U.S. Chicago PMI/Michigan Consumer Sentiment Index