Recession Fears Easing Up?

US Review

Recession Fears Easing Up?

This summer's fears about escalating trade tensions, slowing global growth and an inverted yield curve have let up somewhat as risk-on sentiment made a comeback this week.

With a growing string of economic data coming in above expectations, the 10-year yield has risen 41 bps since reaching a low of 1.46% last Tuesday. The S&P 500 is now just a few points from its all-time high.

Control group retail sales rose 0.3%, setting up consumption for another strong reading in Q3, likely around 3%.

CPI inflation is heating up, but will not deter the Fed from easing next week.

This summer's fears about escalating trade tensions, slowing global growth and an inverted yield curve have let up somewhat as risk-on sentiment made a comeback this week. With a growing string of economic data coming in above expectations, the 10-year yield has risen 41 bps since reaching a low of 1.46% last Tuesday. The S&P 500 is now just a few points from its all-time high. Has imminent Fed easing staved off recession fears?

Markets were likely buoyed by the latest news this week of cooling trade tensions. The consumer, however, continues to be mostly unfazed by the trade war altogether. August retail sales rose 0.4%, off an upwardly revised 0.8% gain in July. Control group sales rose 0.3%, setting up personal consumption for another strong reading in Q3—we now see decent upside to our current PCE forecast of 2.9%. This is slightly softer than the 4.7% annualized pace in Q2, but is more than enough to hold up the broader economy amidst the weakness in the cyclical and trade-exposed sectors like manufacturing and transportation & warehousing.

Meanwhile, monetary policy hawks will be sure to point out that CPI inflation is beginning to heat up more materially. Core prices rose 0.3% for the third straight month, pushing the three-month annualized inflation rate to a 13-year high. The year-over-year rate hit 2.4%, which suggests PCE inflation—which tends to run about 0.3 percentage points below CPI inflation—may finally be at the Fed's target. A few quirks boosted the number, including surging used auto and airfare prices, which we expect to cool in coming months. The rise in goods prices is more important. Core goods had generally been in outright deflation since 2013, but prices are now rising almost 1% over the past year, clearly illustrating the pass-through of tariff costs to the consumer, even before a much broader tranche of goods is subject to higher import taxes.

The NFIB small business confidence survey fell modestly to 103.1, off its cycle high of 108.8 one year ago, but it is still consistent with solid economic growth. Small business owners increasingly see a divergence between conditions today and what they expect in the future—reported sales and earnings remain strong, but hiring and capital spending plans have come down.

Consumer spending—which drives two thirds of the U.S. economy—is growing solidly, core inflation is at a decade high and the stock market is just below a record high. Yet, a Fed rate cut next week is all but locked in. Moreover, we now expect two more cuts after that. The inflation pick-up may generate greater dissent among the FOMC, but it has been moving towards "average inflation" targeting, meaning the Fed would tolerate, or even welcome, above-2% inflation. That rationale is additional cover for it to act more decisively to counteract trade war uncertainty and any contagion from economic weakness overseas—insurance cuts, in other words. The consumer is bearing the weight for now, but job openings are down by over 400,000 since peaking last year and job growth is slowing. More importantly, this week's ‘trade tensions easing' tweet is next week's ‘trade tensions escalating' tweet. Powell has admitted there is no playbook for such a mercurial president, and additional rate cuts seem to be his best move.

 

Global Review

ECB Eases Policy, While U.S. and China Finally Play Nice

The European Central Bank (ECB) cut its deposit rate 10 bps to -.50% and restarted its asset purchase program, while also lowering growth and inflation forecasts. With a more dovish than expected ECB, we now expect the central bank to cut its deposit rate again in December of this year.

U.S. and China trade developments continue to make headlines; however, this time for good reason. President Trump announced a delay in raising tariff rates, while China suggested it may restart purchasing U.S. agricultural products and will exempt certain U.S. products from tariffs.

 

ECB Lets The Doves Out

The European Central Bank (ECB) eased monetary policy on Thursday, moving forward with a slew of measures in an effort to kick-start growth and inflation in the Eurozone economy. These measures included cutting its deposit facility interest rate further into negative territory, restarting its asset purchase program to buy €20 billion per month, introducing a tiered interest rate system for banks in an effort to mitigate the effects of negative rates as well as more favorable lending terms for its Targeted Long-Term Refinancing Operations (TLTRO) program. In addition, the ECB also changed its forward guidance to signal that lower interest rates could in place over the long-term, while the asset purchase program will be open-ended, suggesting it could be purchasing bonds for an extended period of time. While we expected the central bank to cut interest rates and resume asset purchases, we also interpreted Thursday's announcement to be more dovish than we initially expected given the open-ended nature of these actions. Furthermore, the ECB also released updated GDP and inflation forecasts, with the new projections suggesting the Eurozone economy could remain rather subdued for the time being. On Thursday, the ECB lowered its GDP and inflation forecasts, now forecasting 1.1% growth in 2019 and 1.2% growth in 2020, and now forecasting inflation to only be 1.2% in 2019 and 1.0% in 2020. ECB President Mario Draghi also noted that risks remain tilted to the downside as headwinds to the global economy continue to mount. The European Central Bank's more dovish than expected actions, along with Draghi's comments, have led us to revise our ECB forecast, as we now expect another 10 bps cut in the deposit rate in December of this year. Against this backdrop, we would expect the euro to remain under a bit of pressure, although developments in the global economy could have an impact over the path of the currency as well.

 

US and China Easing The Tension

Trade tensions between the United States and China have been a major influence over markets for some time now; however, this week we saw both sides take steps to ease tensions. On Wednesday, President Trump announced he would delay raising previously announced tariffs in an effort to not disrupt the 70th anniversary of the People's Republic of China. In response, Chinese authorities announced they would consider resume purchases American agricultural products, while also naming a wide range of U.S. goods that will be exempt from tariffs enacted last year. Given these measures, markets have renewed optimism a trade deal will be reached. The new hope comes at a good time, as Chinese trade negotiators are set to visit Washington in the coming weeks to continue trade discussions. Despite the goodwill efforts, we believe President Trump will increase tariff rates on Chinese goods in mid- October and will move forward with imposing tariffs on the remaining Chinese goods in December. Tariffs are likely having an impact on the Chinese economy, with Chinese authorities opting to cut the reserve requirement ratios for banks this week, while also taking steps to further open the economy to foreign investment.

 

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