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MCF Capital Markets Update - August 15th, 2019

Tuesday’s rally was the result of a partial Trump reprieve, announcing that some Chinese products targeted in the latest round of tariffs would be excluded or delayed until December 15. Negotiators from both sides agreed to talk in two weeks.[1] The positive news quickly lost steam Wednesday due to a slew of economic data. The market selloff Wednesday was primarily a reaction to concerns of slowing global growth.

In Asia, direct consequences of the US-China trade war continue to dent Chinese growth prospects. Bank lending, factory surveys, industrial output, infrastructure and property investment, and retail sales all showed weaker-than-expected results.[2] Indirect consequences of the US-China trade war are also beginning to appear. Singapore’s Q2 GDP growth sharply contracted 3.3% and projections were slashed to nearly flat through end of year.[3] China is the world’s second largest economy by GDP[4] and the concern for market participants is a contagion of contraction to surrounding regions and trade partners that could lead to a global recession.

Europe’s already struggling economies are facing not only a slowing of growth but an actual contraction. Germany and the UK are Europe’s first and second largest economies by GDP, respectively. In addition to the UK last week reporting -0.4% GDP growth for Q2, Germany reported growth at -0.1%,[5] citing a decline in exports. Another quarter of negative GDP growth would officially place both into recession. In July, ECB (European Central Bank) President Draghi stated that monetary stimulus is necessary to “support the euro area expansion,”[6] reminiscent of comments made by Fed Chair Powell about the US.

To top off recession fears, the prominent 2-year/10-year Treasury yields are now inverted as yields continued to slide. This measure is a traditional omen of recession, but investors should interpret with healthy skepticism. Inversions have occurred that were not followed by a recessionary period. Many possible causes influence Treasury yields. For example, over 47% of global debt excluding the US is negative yielding.[7] Foreign investors looking to earn a positive return on bonds can purchase positive yield through US Treasuries. As more foreign buyers purchase US Treasuries, US yields fall. This current situation is a fundamental contrast to pre-2014 periods, when there were little to no negative yield bonds globally. Comparing the current inversion with past inversions merits attention to shifts in the financial environment affecting the US yield curve and consequent interpretations.

Even if the recent inversion is a true recessionary signal, equity markets typically take several months (sometimes more than a year) to enter recession. Yield inversion is one among several other signals and should not be solely relied upon by investors for making investment decisions. Other US fundamentals are yet to scream recession. We’ve faced late-cycle, recessionary fears the past few years yet few would have accurately predicted the continuing bull run reaching 10 years of age earlier this year. Current conditions warrant caution, but do not necessarily indicate economic doom.

[1] https://www.cnbc.com/2019/08/13/ustr-removes-some-items-from-list-of-new-china-tariffs-citing-health-safety-national-security.html

[7] Bloomberg, LLP


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