Original insights into market moving news

Week in Focus; week commencing 28th October 2019

  • MON: Eurozone M3 Money Supply, US Good Trade Balance, Dallas Fed Manufacturing Business Index.
  • TUE: Tokyo CPI, German Import Price Index, US S&P Case-Shiller, CB Consumer Confidence, US Pending Home Sales.
  • WED: Australian CPI, Swedish Confidence, German Labour Market Report, Regional and National CPI, Consumer Confidence (F), ADP Employment, BoC Rate Decision, FOMC Rate Decision.
  • THU: Australian Building Approvals, Chinese Manufacturing and non-Manufacturing PMI, BoJ Rate Decision, German Retail Sales, CBRT Inflation Report & Minutes, Eurozone CPI, Unemployment Rate, US Challenger Job Cuts, US PCE, Personal Spending, Income, Canadian GDP, Chicago PMI.
  • FRI: South Korean CPI, Manufacturing PMI, Japanese Manufacturing PMI, Chinese Caixin Manufacturing PMI, Swiss CPI, Norwegian Unemployment, US Nonfarm Payrolls, Manufacturing PMI, ISM Manufacturing.


Market-derived probability implies at 90% chance the Fed will cut rates by 25bps to 1.50-1.75%; indeed, key policymakers did little to push back on market pricing before the Fed entered its 'blackout period' ahead of the October confab. The decision to lower rates will likely face dissent from Presidents Esther George and Eric Rosengren once again. HSBC's analysts explain that the Fed has consistently given three reasons for easing: to mitigate the effects of slowing global growth on the US economy, manage downside risks, support the return of inflation to target; "we believe that a majority of the Committee is still inclined to deliver on the third part of the 'mid-cycle adjustment' that Fed Chair Powell has repeatedly alluded to ever since the first 25bps rate reduction back in July," the bank writes, however, it does not think that the FOMC will necessarily make any major adjustments to its policy statement, and is likely to reiterate for the third time that the Committee "contemplates the future path of the target range for the federal funds rate, it will continue to monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion, with a strong labour market and inflation near its symmetric 2% objective." In the press conference, Powell's comments will be parsed for signals whether another 2019 rate cut is coming, or whether the FOMC will move towards a 'wait-and-see' approach, where the hurdle for additional cuts would be higher, HSBC says. The market will also be looking for remarks about repo operations; HSBC notes that the FOMC held a video conference on 4th October to discuss issues related to the money market pressures, and on 11th October, it announced that it would not only continue to conduct term and overnight repos through at least next January, but also that it would seek to boost the level of bank reserves in the system on a permanent basis through purchases of Treasury bills. This week, the Fed once again boosted the size of its operations. The Fed has been keen to emphasis that these repo operations are merely technical, not a resumption of the type of QE seen during the crisis. Analysts at Capital Economics are not expecting the Fed to follow that up with further measures next week, but says that with the fed funds rate still unusually volatile in recent weeks, there is a good chance policymakers will ultimately need to undertake more frequent open market operations or introduce a standing repo facility to provide liquidity.


The Street expects 105k nonfarm payrolls to be added to the US economy in October, with the headline being dragged by a strike at General Motors (GM); the jobless rate is seen ticking up by one-tenth to 3.6%; however, average hourly earnings are seen rising slightly to 3.0% Y/Y from 2.9%. The pace of payroll growth has already been moderating in recent months (12-month average 179k, 6-month average 154k, and the 3-month rate is at 157k). Looking at September data, Capital Economics says that the 136k was flattered by a 24k rise in state and local government employment. "That did not include any hit from the strike at GM, which began in mid-September; that is because the establishment survey, which is the source of the non-farm payroll figures, counts a person as employed if they were paid during the pay period including the 12th of the month," and CapEco notes the 48k GM weekly and bi-weekly wage workers on strike were paid in the week leading up to  the strike in September, but they will not be included in October’s count. CapEco also writes that the impact further up the supply chain is less certain; there are estimates that up to 200k workers at GM suppliers might have been affected, though initial jobless claims data offers a more sanguine estimate of 12k in key GM production states. Ahead, there may be more furloughed workers that are yet to make a jobless claim. As a point of comparison, the GM strike in 1998 reduced payrolls by 132k, though CapEco believes that the impact has been less severe this time around. CapEco therefore estimates that the overall hit to October payrolls from the GM strike will be close to 80k. Away from GM, upside may be provided by census hiring; so far, the government has hired 28k temporary workers of a targeted 40k. Nevertheless, CapEco says that putting these temporary distortions aside, it still expects a gradual slowdown in the underlying pace of employment growth, arguing that Markit PMIs, for instance, are consistent with the pace of payrolls grinding to a halt in the months ahead (though these surveys may have been impacted by GM, too).


The Street expects the first look at US Q3 GDP to show growth of 1.6% in Q3, paring from a pace of 2.0% in Q2. The slowdown in the pace of growth may prompt many column inches to be dedicated to the probability of an upcoming recession in the US, particularly given some of the ominous signs within the manufacturing sector. However, most are not projecting a recession any time soon. Oxford Economics does not see a recession, though says that the lingering industrial slump is increasingly at risk of spilling over into the broader economy: "This is particularly true since the ongoing weakening in global activity comes at a time when the US economy is no longer fiscally insulated and businesses are feeling the pinch from squeezed profit margins." The consultancy has forecast growth of 2.2% this year cooling to 1.6% in 2020, and has assigned a 40% probability of a recession. "Two key transmission channels could lead to contagion from business investment to the broader economy: weaker employment if strained businesses pull back on hiring, hours or wages, and slumping confidence if businesses, consumers and investors succumb to the 'recession bias'." The Consultancy stresses that rising trade tensions and the risk of tightening financial conditions are two key factors that could not only prolong the industrial slump but also lead to more rapid contagion via employment and confidence.


From a financing need perspective, Treasury net issuance of T-bills will likely come in around USD 49bln in Q4 2019, USD 175bln in Q1 2020, and sees USD -88bln in Q2 2020, according to Wells Fargo. However, Wells says these estimates are before accounting for Fed purchases; after adjusting for the Fed, it estimates that the net supply of T-bills will be USD -103bln in Q4, USD 54bln in Q1 and USD -116bln in Q2 2020. Wells expects the Fed to purchase over half of the total net Treasury security issuance from Q4 2019 through Q2 2020, estimating that these purchases should total around USD 480bln. "In our view, these purchases, combined with the Fed’s commitment to remain active in repo markets, will be enough to keep funding rates in check over the next few months," adding that "there may be small stretches where things are a bit rocky, particularly around year-end, but we think the Fed will be able to keep repo rates within the fed funds target range on most days." Meanwhile, Wells thinks that coupon auction sizes appear appropriate for at least the next few quarters, but notes that a rising tide of maturities of notes and bonds is approaching, and therefore, it expects auction sizes to rise again in the second half of next year. Wells says it assumes all nominal coupon auction sizes will be bumped up by USD 1bln in the calendar year Q4 2020 refunding. "We expect Treasury to unveil a similarly sized increase a quarter or two later, and it may avoid across-the-board increases in auction sizes by adding a new maturity to the menu. "We think a 20-year Treasury security makes more sense than a 50-year, or a 100-year." The Treasury could introduce the 20-year in late 2020, and a starting point for the auction size could be around USD 14bln/month; the bank adds that the new security likely would be accompanied by modest reductions in auctions elsewhere on the curve.


The US Treasury's semi-annual currency report is due for release in October, but Politico has reported that the timing of the release could depend on whether the US administration's efforts to conclude the "phase one" deal with China proceed smoothly, or break down between now and the APEC meeting in mid-November. After the Treasury designated China a currency manipulator in August, markets will be eying its explanation. In its previous report, the Treasury tweaked the criteria required to receive such a designation, and analysts believe that China only meets one of the three criteria (it has a large bi-lateral trade surplus above USD 20bln; analysts do not believe conditions of a current account surplus above 2% and large one-sided FX interventions tests have been satisfied), whereas the designation of 'currency manipulator' requires two of the conditions to be met. There is, therefore, a possibility that the US could rescind its designation, has has been hinted by US Treasury Secretary Mnuchin in recent weeks; such a move will be seen by the market as a positive for US/China trade negotiations.


Attention will be on the NBS manufacturing PMI, which the market thinks will tick down by 0.1 point to 49.7. However, analysts at Citi are slightly more optimistic and projects 49.9 - a rise, albeit still beneath the key 50.0 neutral mark. Citi sees the production index improving on the back of higher coal consumption by power plants. It also thinks that the infrastructure push by the government could support domestic orders, while export orders might not weaken further ahead of the year-end shopping season in the West.


The consensus expects the manufacturing ISM to rise to 49.0 in October, from 47.8 (NOTE: ISM itself says that over time, a PMI above 42.9 indicates an expansion of the overall economy). Analysts point out that the strike at GM could also impact this data series. From the perspective of regional manufacturing surveys, the read has been mixed. Nordea’s analysts are leaning towards another weak print, with downside risks to the consensus; “lately, it is especially smaller order books both domestically and from abroad that have taken the manufacturing index into contractionary territory over the last four months,” and any “further decreases in these indices will indeed put more pressure on the Fed to do more to support the expansion.”


On Tuesday, UK Parliament voted (in principle) in favour of the government’s EU Withdrawal Agreement Bill (WAB) 329-299. Minutes later, the accompanying Programme Motion presented by the government, which had sought to push through the legislation within three days, was rejected by parliament; many MPs who had voted for the WAB in principle argued that more time was needed to properly scrutinise the bill, as historically a three day timetable is short. Upon the motion’s defeat, UK PM Johnson announced a pause to the passage of legislation and is now pushing for an election on 12th December, on the assumption that the EU will grant an extension through 31st January 2020. Most EU leaders appears to favour an extension until end-January – that is the date requested by the UK government, and it might be seen as the most neutral extension length to offer (a shorter extension would favour UK PM Johnson by putting more pressure on MPs to accept rapid implementation of the WAB out of fear of no deal, while a longer extension would be seen to favour Remainers pushing for a second referendum). France, however, have been pushing for a shorter extension, with 15th November touted. However, it is worth noting that the EU has repeatedly said that it needs a good reason to grant a lengthy extension (an election or second referendum would meet its criteria) and appears to be awaiting the outcome of parliament’s vote on Monday before making a final decision on the length of the extension. This leaves the risk that the process could be stuck in limbo; the UK opposition parties say they will not agree to an election until an extension has been granted (so no deal is “off the table”), while the EU say it will not grant an extension until a UK election has been agreed to. With Johnson’s 12th December election motion likely to fail on Monday (given that it requires two-thirds of lawmakers, or 434 MPs, to back it), the arguments of those within the EU pushing for a shorter extension may carry more weight, although a “tiered extension” could please most (an extension that could initially end on 15th November to allow time for the passage of the WAB and, failing that, be extended to a later date, possibly to allow for an election). Recent YouGov polls have the Conservatives firmly in the lead at 37% vs Labour’s 22%. As such, although opposition Labour leaders have said they are eager for an election, many of its MPs are reportedly reluctant, preferring to delay an election into 2020; raising the risk of a “Zombie parliament” (one that does not back a deal or election). “If MPs reject a December election, we suspect the PM will refocus on getting the Brexit legislation through Westminster” says ING, given that a delay to both Brexit and an election is likely endanger the Conservatives lead in the polls (voters may punish them for failing to deliver Brexit).


The market expects CPI to have risen by 0.5% Q/Q in Q3, paring a touch from the 0.6% pace seen in Q2. The data comes ahead of the RBA's SOMP (8th November); Westpac's analysts are slightly ahead of consensus expecting a print of 0.6%, which would take the annualised rate to 1.8% Y/Y from 1.6%; its analysts say that upside will come from holiday travel and accommodation, alcohol & tobacco (due to the annual re-indexing of tobacco excise) and food (drought offsetting normal seasonal softness); housing costs are to rise 0.2%, Westpac believes, as the solid 3% seasonal rise in property rates and charges offsets flat rents, and falling dwelling purchases and utilities prices. The headline may also see some support from the minimum wage hike seen in the quarter.