Equity markets fell for the fourth-consecutive week due to a sharp intraday selloff on Friday in reaction to President Trump’s criticism of Fed Chair Powell and an escalation in the trade war with China. Despite the prolonged losing streak, the S&P 500® Index remains only 6% below the all-time high from July and has returned 15% year to date.
Fears of a recession are growing as the inverted yield curve has drawn attention and economic data is increasingly mixed. Fed Chair Powell said in a speech at the Jackson Hole Economic Policy Symposium that the Fed will act as appropriate to sustain the expansion and noted that the three weeks following the July meeting have been “eventful.” Inflation is approaching the 2% target of the Fed, which may limit flexibility to cut rates. The words “risk” and “uncertainty” showed up an unprecedented 69 times in the latest FOMC minutes, up from 48 at the previous meeting. This is more than what we saw at any meeting during the Great Recession or after the technology bubble. The Fed Futures curve currently embeds a 100% chance of a cut at September’s meeting and a 42% chance of three-or-more cuts this year (up from 17% a month ago). Betting markets show a 44% chance of a recession by next year’s election, while a WSJ survey puts the odds at one-in-three. Perhaps those fears are exaggerated, as consumer confidence and retail sales trends show the consumer (70% of the economy) in reasonably good shape.
China and the U.S. are sending mixed signals on the state of trade negotiations. Friday saw a steep decline following word that China will retaliate with tariffs on $75 billion of U.S. goods in September and resume 25% tariffs on U.S. autos in December. On Monday, Trump said that China has asked to restart trade talks and that the administration received two “very productive” calls from Chinese officials, though China’s Foreign Ministry is not aware of those calls. Reports show that the U.S. reached a trade deal “in principle” with Japan that would send more agricultural products to Japan and limit incremental tariffs on Japanese cars. While news of trade deals has frequently provided some short-term market relief, there is likely some remaining heavy lifting to come to drive the U.S. and China to a deal that is acceptable.
Interest Rates: Global rates continue to collapse, with the 10-year briefly dropping below 1.5% and the 10-year/2-year ending last week inverted. With inflation approaching 2%, the real yield is negative across the curve excluding the 30-year. Germany issued a 30-year bond with a negative embedded yield last week for the first time. The low rates and yield curve inversions remain primarily driven by technical factors (low global rates and insatiable demand for yield), though economic storm clouds demand attention.
Geopolitical Tension: While the world’s attention is focused on the trade dispute between the U.S. and China, other geopolitical uncertainty is worth watching. South Korea ended a pact to share military information with Japan in retaliation to growing trade tensions between the two countries. India and Pakistan remain bitterly divided over the disputed area of Kashmir as India has become increasingly involved in the previously autonomous Muslim-majority state. Clashes continue between police and protestors in Hong Kong, as 36 people were arrested in protest over the now-suspended extradition bill that would have allowed Hong Kong people to be sent to mainland China for trial. While most of the conflicts are local in nature, they are weighing on global confidence and growth.
Tax Cuts: President Trump said Saturday that he would approve a “major middle-income tax cut” if Republicans control the presidency and both houses of Congress following the 2020 election. There were no details on the plan, though economic advisor Kudlow said Thursday that the administration was looking at “tax cuts 2.0” to drive economic growth. There was initial speculation of a payroll tax cut, though the administration walked that back. Investors are justifiably skeptical of these discussions, because the current environment allows little change of an agreement until after the election.
What to Watch
A wave of economic data hits this week, including durable goods on Monday, consumer confidence on Tuesday, revised second-quarter GDP and pending home sales on Thursday, and PCE deflator, personal income and spending, and consumer sentiment on Friday.
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