Navigating under a cloud strewn sky

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The Federal Reserve’s policy pause has time on its side, to borrow a tune from the Rolling Stones. Friday’s resilient US employment data, typified by service sector strength, keeps the consumer rolling along and helps offset a gloomier tone in manufacturing and business investment.

Wall Street joined a global equity rally with sentiment buoyed earlier by China’s Caxin manufacturing report (See Quick Hits for more on that). This was further boosted by a “constructive” phone call on Friday between US officials and China’s vice-premier on phase one of the US-China trade agreement, which also pushed up oil prices. The Nasdaq has joined the S&P 500 in record territory. As shown below, global equities, with just under two months left for 2019, are on course for the kind of performance witnessed in 2017, a year defined by a synchronised global expansion.

One can argue that equities may well have jumped the gun here as plenty of good news is now priced before any upturn in activity and earnings growth. It is telling when looking at flows this year that plenty of money has favoured bonds and skewed towards defensive areas of equities. A shift from defensive holdings could well propel equities even higher into year-end.

For a sign that a rebound in activity is gathering pace, it’s worth highlighting Friday’s price action on both sides of the Atlantic. For the S&P 500 and Europe’s Stoxx 600, cyclicals are leading the way. The energy, industrials, materials and financials sectors lead Wall Street, while basic resources, autos & parts and oil & gas top the Stoxx 600.

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But a degree of caution is underscored by modest selling in Treasuries and eurozone government bonds, while the dollar neared its lows for the week. Later in the New York morning the headline ISM manufacturing figure for October bounced to 48.3, but arrived below a forecast 48.9. The ISM production index fell to its lowest level since April 2009. In short, manufacturing remained in contraction, although broad activity had improved for the first time since March. 

After Friday’s US data, both the two- and 10-year Treasury yields notably remained below their pre-Fed meeting levels of 1.61 per cent and 1.79 per cent respectively as the week drew to a close. The dollar index has also failed to recover ground lost since Wednesday afternoon and sat at its lowest level since mid-July. 

The bottom line is that while the case for a Fed pause has been affirmed by Friday’s jobs report, the narrative can shift before the end of the year, particularly given the back and forth seen over trade negotiations in the past 18 months between the US and China. 

Alan Ruskin at Deutsche Bank makes an interesting point about the relationship between markets and the Fed:

“The market has a deep scepticism that the Fed really knows much more than the collective wisdom of the market on the growth outlook. ‘They’ (the Fed) are looking at ‘us’ (equities, the yield curve et al), and we the market, are looking at them, in a veritable echo chamber — as ‘we’ are both looking at the same data.”

Still, the US jobs data did bolster risk sentiment, as highlighted by a humming service sector, with private job gains of 157,000 in October, after prior monthly figures of 160,000 and 159,000. That resulted in a three-month moving average for private payrolls of 154,000, up from an unrevised figure of 119,000 a month ago. 

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A firm backing for the consumer likely keeps the Fed on the sidelines when officials gather in December. For all that, policymakers, investors and markets are still navigating under a cloudy sky with some fleeting periods of seeing the stars glittering above them. 

Finally, the onset of November means Blade Runner is now a film set in the present, or Los Angeles of 2019. And yes, I watched this masterpiece in a sparsely populated cinema when it was released 37 years ago. “All those moments will be lost in time, like tears in rain.”

Programming Note

Markets Forces is taking a small break and returns on Tuesday of next week. 

Quick Hits — What’s on the markets radar

US employment surprised to the upside of expectations for October, with 128,000 new hires, beating a forecast 85,000 rise, while September was revised up to 180,000 from an initial 136,000. The General Motors strike registered last month as motor vehicle and parts manufacturing payrolls declined 42,000. The unemployment rate rose 0.1 per cent to 3.6 per cent, matching estimates.

Wage growth for the past 12 months remained steady at a 3 per cent pace (September was revised up from an original 2.9 per cent read), with this measure easing after peaking at 3.4 per cent in April.

High Frequency Economics notes the year-on-year pace for wages “is identical to the 3.0% 2018 average; it is up from 2.6% in 2017”.

A tale of two manufacturing measures for China this week A surprise expansion in the Caixin Purchasing Managers index prompted a better day for Chinese equities and helped European markets. The October Caixin PMI, which covers smaller companies,arrived at 51.7 (51.0 was forecast) in October. New orders for the Caixin PMI climbed at their fastest pace in more than six years. China’s official manufacturing index eased to 49.3 last month from 49.8, but this focuses on larger companies. 

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The divergence between the two PMIs released this week, argues Brown Brothers Harriman, is “likely a reflection the how Chinese policymakers are administering their targeted stimulus measures”.

Another factor for consideration is how China’s trade-sensitive neighbours remain under pressure. South Korean exports fell minus 14.7 per cent for the year to October, which follows a year-over-year slide of minus 11.7 per cent in September. Japan’s manufacturing PMI was 48.4 for October, down from 48.9 the prior month. 

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