Equities are finding a bid this morning as China and the U.S. wrapped up three days of talks with hints of optimism characterizing the preliminary talks (stop us if you’ve head that before). The trade scuttlebutt is offsetting the president’s Oval Office address last night that didn’t include invoking a national emergency declaration that could have allowed the president to avoid the necessity of congressional approval for his long-promised border wall. Instead, the address was mostly a repeat of campaign-style themes on immigration and the border wall, and thus leaves no clear path forward to resolving the government shutdown. We talk more about the issue below and the likely impact it will have on yields in the coming months. Meanwhile, this afternoon the minutes from the December FOMC meeting will be released, but the caveat here is the minutes occurred prior to the S&P slipping 8% into year-end and before the government shutdown began. In any event, how much time is spent discussing the global-slowing story will be interesting as that factor has only increased subsequent to the meeting. Voting members Evans (neutral) and Rosengren (modestly hawkish) will speak today on the economy providing us with a more current look at Fed thinking. Chairman Powell will speak tomorrow in New York.
|Economic News||German Industrial Production Slows to Decade Low||Agency Indications|
The government shutdown is nearing the longest in history, (this weekend will mark 22 days and a new record), and while the economic impact is still minimal tell that to the 800,000 government employees and their families that are about to go without a paycheck as the shutdown encompasses its first full pay cycle. Add in the increasing sick-outs by TSA screeners, and a myriad of other posts that are either not manned or manned at skeletal levels, and the impact to the public is increasing.
Despite the promise that the IRS will process and pay tax refunds, the backlog with partial staffing is likely to increase rapidly. We highlight these points to note that while the macroeconomic cost to date is easily absorbed, the inconvenience and perhaps safety considerations will start to build with the public and that is likely to shift more 2020-vulnerable Republican senators to consider the House’s bill to reopen the government that was passed last week. While Majority Leader McConnell is doing the White House’s bidding and showing no inclination to bring the bill to the Senate floor for a vote—-perhaps knowing it would easily pass—the pressure will continue to build on him to do so. The larger picture, however, in the inability to work through the funding of government is that it doesn’t provide investors, or the general public, confidence that other issues—like the soon-to-be-expiring debt ceiling exemption—will be handled in a timely or competent manner. Thus, stock rallies will continue to struggle and that will keep any back-up in Treasury yields modest as investor confidence remains low and subject to the day-to-day whims of the administration.
Also impacting investor confidence is the increasing concerns over a global slowdown. Much has been made of the softening in China and the impact that is having not only on their economy but also to the U.S.-China trade negotiations. With the recent slowing in some U.S. economic indicators the impetus on both sides to get something resolved is strong. Thus, you heard on Monday that there has been progress made in the trade negotiation talks. We’ve no doubt both parties are sufficiently motivated to get something tangible approved, but we are less sanguine that once a deal is announced everything will revert to prior form. Business confidence doesn’t work like that. Just look at the NFIB Small Business Optimism release for December. The series has given back all of the confidence gained following the November 2016 election and that is likely to temper expansion and/or employment plans in the near future.
Putting the trade issue aside for a moment, consider that China is something of the manufacturer to the world. Also, recall too that nearly 40% of S&P 500 company earnings come from overseas sources. So the softness in China’s economic results reflects more than a slowing in domestic demand but more broadly a slowing in global demand. That slowing will impinge not only on Chinese companies but all manner of multi-nationals. That softness is also keeping downward pressure on all manner of commodities and the signs of global slowing are increasing.
Germany is at the precipice of recession as November industrial production fell 1.9% in December —the steepest decline since 2014 and a –4.7% YoY decline. 3rd quarter German GDP was –0.2%, so back-to-back negative quarters (meeting the definition of recession) look likely for the dominant economy in Europe. In addition, output contracted in other Eurozone nations as well including Italy, Sweden and Switzerland. Add in the troubled Brexit negotiations and it doesn’t bode well for the Continent or the U.K. in early 2019.
Overlay the economic slowing (or at least moderation) in all major global regions with the increasing political dysfunction in most of those areas as well and it adds another headwind that complicates the picture for those calling for economies to quickly regain their footing once the trade protectionism soft-patch has been resolved. First, we’re not so sure a U.S.-China “deal” halts the protectionism trend, nor do we think the current phase of geopolitical entropy will end anytime soon and that will challenge not only political leaders but business leaders as well. Maintaining investor and consumer confidence in such a landscape seems challenging at best. Thus, we think the recent rally in longer Treasuries has staying power with the capacity for further moves lower in yield.
German Industrial Production Slows to Decade Low
The softening in the Chinese economy is a well-known development that continues to weigh on global growth prospects. Add to that the recent weakening in the Eurozone’s leading economy Germany and the case for spreading global weakness looks a little more compelling. Yesterday, Germany posted the biggest annual drop in industrial production in nearly a decade and given the manufacturing-heavy nature of Germany it could be enough to push Europe’s leading economy into recession. With weakening in some U.S. numbers of late, combined with the China and Germany slowdown, a global slowdown seems to be gaining traction.
Agency Indications — FNMA / FHLMC Callable Rates