Speculation that the trade deal could be pushed into early 2020 or potentially after the U.S. election at the end of 2020 tempered gains of risk assets over the past four weeks as global manufacturing indicators pointed to expansion. The S&P/ASX is largely flat along with the Euro Stoxx 50 and Nikkei 225. The U.S. S&P 500 rose 1.7% over the month as employment figures were again stronger than expected indicating resilience. China was again the big underperformer, with the CSI 300 index shedding 2% as Hong Kong protests rage on and the U.S. passed a bill on Hong Kong in support of the protestors.
Commodities mostly rebounded following the positive global manufacturing indicators with growth-sensitive oil and copper rising around 3%. Iron ore prices rebounded above U.S. $90. Meanwhile, safe havens like gold and silver continue to pull back.
Oil rose, recuperating some of the earlier losses in September. Iron ore continued to fall sharply to around U.S. $80 whilst industrial metals like copper were steady. Gold and other precious metals fell as risk sentiment rose.
Bonds retraced some of their losses from the previous months as the U.S. 10-year yield fell by 0.11% to 1.83% and the Australian 10-year yield fell by 0.14% to 1.15%.
The Australian Dollar remains little changed at 68 U.S. cents.
Local economic data released over the past four weeks were pretty gloomy but most of these related to the third quarter rather than forward-looking indicators. Private sector spending and borrowing remain lacklustre whilst building approvals and retail sales also missed expectations. The third-quarter GDP of 0.4% also missed expectations of 0.5% with the year on year growth of 1.7% well below the long term trend.
U.S. economic data was encouraging, with another month of strong employment figures that blew estimates out of the water and manufacturing PMIs (Purchasing Manager Indices which are leading indicators of activity) surprised positively. European manufacturing PMIs also surprised positively but continue to indicate contraction.
Importantly, China’s targeted easing policies look to be taking effect as PMIs for both manufacturing and services beat expectations, with manufacturing bouncing above the key level of 50 which separates expansion from contraction. Just prior to the release of this data, the People’s Bank of China cut short-term rates by 0.05%.
Moving forward, the near-term key risk remains an escalation of tariffs remains scheduled for 15 December unless a ‘Phase One’ deal is agreed. This round of tariffs is set to hit consumer products directly which is expected to have more severe repercussions for the U.S. consumer than previous rounds.
Monetary policy and tariffs are fighting over economic growth
For much of 2018, central banks were tightening either by stopping Quantitative Easing like the European Central Bank or raising interest rates or in the case of the U.S. Federal Reserve; Quantitative Tightening. There tends to be a delayed effect from monetary tightening on the economy which could explain the slowdown in 2019 after much of the tightening occurred in 2018. With central banks then pivoting quickly back to monetary easing at the start of 2019, we may start to see global growth rebound in early 2020 as the chart below suggests.
With solid beats in manufacturing PMIs of large countries like U.S., Europe and China over the past few weeks, global PMIs are starting to rebound from their lows. November marks a return to expansion for global manufacturing and as per the chart below, the global manufacturing PMI composite by J.P. Morgan rose to 50.3, above 50 which marks the dividing line between expansion and contraction.
However, the return to manufacturing growth remains fragile given the potential for an escalation in tariffs between the U.S. and Europe, or U.S. and China, or the U.S. and other countries. The chart below shows the split in performance between consumer goods versus the intermediate and investment sectors of the manufacturing PMI.
As seen in the chart, it has been the intermediate goods and investment that have been driving the fall in PMIs since early 2018. Tariffs between the U.S. and China have so far primarily targeted the intermediate goods sector whilst the uncertainty around potential escalation has hurt investment. Though monetary easing has helped these segments bottom out, the potential ‘Phase One’ deal or escalation of tariffs for U.S. imports from China on 15 December represents a key potential turning point. A ‘Phase One’ deal and rollback of tariffs, either partial or full, would have huge positive implications for the intermediate and investment sectors but a no-deal and implementation of planned tariffs which primarily targets the consumer sector would send the global manufacturing PMI tumbling back to contractionary levels, potentially causing a recession prior to the 2020 U.S. election. No incumbent has ever won re-election in a recession year, hence markets look like they have priced in a ‘Phase One’ deal as the most likely outcome in recent months.
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