Week Ending: July 5th, 2019 | Published: July 8th, 2019
The first half of 2019 has brought stellar results from equities and fixed income. For our thoughts on what the second half of 2019 will bring, read GLC’s 2019 Mid-Year Capital Market Outlook – The Bull Market in Everything: Investment positioning for times that can’t last forever.
The week finally brought a break in the bull market for everything. Equities won the week, celebrating the G20 détente in U.S.-China trade relations. Bonds lost ground as yields broke their relentless downtrend on the back of the strong U.S. payrolls report. The S&P 500 and Dow Jones Industrials set new all-time highs mid-week before also retreating on Friday’s U.S. jobs report – good news for main street (jobs and wage gains) isn’t necessarily good news for Wall street. Equities have been powering up on falling bond yields and the expectation of support from central banks. And, the U.S. jobs report (and indeed the solid wage gains in the Canadian employment report) walks back the timing and extent to which North American central banks may or may not cut interest rates. U.S. Federal Reserve (Fed) officials have also been out talking down a 0.5% cut in the near term. For the U.S., market-based odds are still pricing a 99% chance of a 0.25% cut on July 31, but the chances of a 0.50% rate cut at that upcoming meeting fell from 26% prior to the jobs report to just 1.5% after. However, markets are still pricing a 72% chance that the Fed Funds rate is 0.5% lower by September’s meeting. In Canada, odds are just 25% for any rate cut by year’s end.
As we expected with China trade tension moving from roiling to just a low boil, it didn’t take long for the U.S. to pivot their trade war toward Europe. They threatened tariffs on another $4 billion of European imports, on top of the $11 billion that was announced in April. The Europeans retaliated with their own list of $20 billion of U.S. products that could be hit with tariffs. The key battle ground between the U.S. and China is technology, whereas for Europe it’s autos and airplanes. Each of these are viewed as high innovation, high value-add, high employment, strategic areas of the future. This makes them not just trade disputes, but battles for supremacy in the most coveted industries. The trade war’s impact on global manufacturing is starting to bite. Most global manufacturing purchasing manager indices are falling, and the JP Morgan Global Manufacturing PMI Index fell 0.4 to 49.4 in June, marking a second monthly reading below the 50 expansion/contraction demarcation line.
While the week saw equities win, Friday’s trading action brought weakness for both stocks and bonds. This is a wakeup call to the fact that equities and bonds currently share a level of interdependence we believe is unhealthy. For both stocks and bonds to escape unscathed going forward, monetary policy needs to be accommodative enough to justify the low yields (due trade frictions, low inflation and weak growth), but growth and trade can’t deteriorate to such an extent that equities need to retreat from their lofty levels. This ‘central banks thread the needle perfectly’ scenario is possible, but not one we see as likely to arrive without a shakeup for capital markets broadly (i.e., we think investors should brace for volatility in stocks, bonds and currencies).
Chart of the Week: The Loonie Bear Squeeze
Currency traders have been shorting the Canadian dollar for over a year, but recently they have been capitulating, scrambling to cover those bets. A measure of short bets on the Canadian dollar is the weekly (on Tuesdays) Commitment of Traders Report to the U.S. Commodity Futures & Trading Commission (CFTC) from the Chicago Mercantile Exchange (CME) a series known as the Canadian Dollar Leveraged Funds Net Total Combined Positioning Report (measured in # of contracts). Data from this series (up to June 25) shows short bets on the loonie shrinking at their fastest pace since July of 2017. The sharp move for the Canadian dollar is being driven by fundamentals: better Canadian economic data and the narrowing differential between 2-year U.S. and Canadian bond yields (CDN 2-yr less U.S. 2-yr = -0.23%, an 18-month low) but the move is exacerbated by the short covering. The net shorts are just about gone, suggesting the velocity of the appreciation for the loonie will subside. What the loonie needs now is for traders to go long – we’ll be watching tomorrow’s update for this sign.
For more of what capital markets doled out in the first half of 2019, be sure to check the GLC 2019 Mid-Year Market Review.
The week in review
Canadian employment (June) fell by 2,200 (versus expectations of +9,900) and the unemployment rate rose 0.1% to 5.5%. The soft headline number is not surprising given the torrid pace of hiring thus far in 2019 (the YTD monthly gain is averaging a healthy 41,000 jobs). Additionally, the details of the report were strong: full-time employment rose 24,100 as all the losses were in part-time and self-employed positions. Average hourly wages came in well above expectations, accelerating from 2.6% to 3.6% y/y (versus 2.7% expected); the 1.0% s.a. gain marks the largest monthly gain in more than 20 years of data.
Canada’s merchandise trade balance (May) swung to a surplus of $762 million compared to an upwardly revised deficit of $1.08 billion in the prior month – the first surplus in 11 months. Exports surged 4.6% m/m, while imports were up 1.0%.
U.S. non-farm payrolls (June) blew away expectations – expanding by 224,000 (versus 160,000 expected). This is the largest increase of the year and brings the average YTD monthly gain to 172,000. Average hourly earnings continued to grind higher, up 0.2% m/m, but the y/y trend fell 0.1% to 3.1%, a 10-month low. A 0.1% increase in the participation rate to 62.9% lifted the unemployment rate 0.1% to 3.6%.
Eurozone retail sales (May) fell 0.3% m/m (versus +0.3% expected). In better news, the Eurozone jobless rate (May) fell 0.1% to 7.5%.
June global PMI recap: U.S. ISM manufacturing fell 0.4 to 51.7, non-manufacturing fell 1.8 to 55.1; Canada Markit manufacturing rose 0.1 to 49.2, Ivey manufacturing fell 3.5 to 52.4; Eurozone Markit manufacturing finalized at 47.6 (versus 47.8 in initial reading), services was revised up to 53.6 from 52.9; U.K. manufacturing fell 1.4 to 48.0, services fell 0.8 to 50.2; Japan services rose 0.2 to 51.9; China official manufacturing remained flat at 49.4, official non-manufacturing dropped 0.1 to 54.2; China Caixin manufacturing fell 0.8 to 49.4, services fell 0.7 to 52.0.
The week ahead
Canadian central bank policy meeting and housing data
U.S. and European central bank meeting minutes released
U.S. and China inflation data
Fed Chair Powell Congressional testimony
China trade, money supply and lending data