Geo-political events recently escalated in the Middle East with a drone attack on a Saudi Arabian (Aramco) oil facility over the weekend. Brent Crude oil jumped 10% over the weekend due to the expected disruption. Houthi rebels from Yemen, supported by Iran, have claimed responsibility for the attack. Secretary of State Pompeo places blame solely on Iran; the Saudi government has yet to determine responsibility. The full impact to world oil production is still unknown but the primary concern for markets would be the risk of further escalation between the top five oil producers and OPEC neighbors.
Trump toned down his combative trade rhetoric, instead letting tariffs do the talking. Senior White House adviser Peter Navarro says that tariffs are the best defense and insurance policy for good faith trade negotiations, and are “working beautifully.” China extended an olive branch last week, exempting a small list of US imports from additional tariffs for one year. Trump then delayed a 5% tariff increase from October 1 to October 15. Both are token gestures of concession. Trade talks between teams are scheduled for mid-September. Another escalation could happen before then and a resolution is not expected anytime soon. Equity markets have taken notice of the calmer trade rhetoric from both sides, steadily climbing over the past week.
The European Central Bank (ECB) announced monthly asset purchases of €20 billion (~$22B) and pushed the deposit facility rate further negative to -0.5% (banks must pay the ECB to hold bank deposits there). The Fed is lockstep with the ECB on looser policy, both making comments to achieve the 2% inflation target at all costs, with negative interest rates possible. Unlike the Fed who framed its most recent rate cut as a “mid-cycle adjustment,” the ECB flatly admits a highly accommodative stance “for a prolonged period of time.” Market participants expect the Fed to follow.
The overarching theme is that slowing global growth is forcing central banks to respond. The ECB 2019 GDP projection for the Euro area is only 1.1%; Germany and the UK contracted last quarter. China’s slowing economy surprised many, triggering the August 14 selloff. Latin America is expected to grow an anemic 0.6% this year. US bond markets were much quicker than central banks, picking up on stalled global growth as early as October of last year, with Treasury yields steadily falling across the curve as investors shifted to safe-haven assets. The 10-year yield hovered in the 3.1% range in October but dropped precipitously, falling as low as 1.47% at the beginning of this month (Friday’s close was back up to 1.9%). Recession risks have increased but a recession in the near future is not a forgone conclusion; most economies are still growing, just at a lower rate.
Looking at economic indicators, the JOLTS report was mixed with a drop in the number of job openings but a pickup in job quits. Jobless claims have also held steady, an indication of a strong and stable labor market. PPI is showing signs of a pickup in inflation. Retail sales beat expectations and consumer sentiment made a modest rebound despite the recent trade tensions.
None of these indicators are likely to change the likelihood (~80% chance) for the Fed’s expected 25 basis point cut at their meeting this Wednesday. This week will also see reports on manufacturing, industrial production, and housing.
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