Cbanks cut rates as manufacturing gloom deepens
After a torrid August, financial markets recovered somewhat in September, helped by a more stable trade war climate – followed in October by a limited deal between the US and China that removed near-term tariff hikes – and looser monetary policy by both the US Fed and the ECB.
Major equity indices rose around 2-5% and bond yields edged back up from September’s multi-year lows, though 10-year yields remain negative across parts of Europe and Japan.
The oil market however was rocked by attacks on Saudi oil facilities that saw oil prices surge, before falling as Saudi production recovered and markets returned their focus to the deteriorating global growth outlook. US manufacturing weakens again, but jobs market strong In the US, there has been more evidence that economic activity is softening. Most alarming was the manufacturing ISM index, which dropped even further into negative territory at 47.1 in September, and a 10-year low amid heavily contracting export orders and trade pessimism. But also concerning was the decline in the non-manufacturing equivalent to a three-year low of 52.6.
Meanwhile however, the jobs market remains strong, underpinning still reasonable growth in consumer spending. Non-farm payrolls rose a decent 136,000 in September and the unemployment rate fell to a 50-year low of 3.5%. One concern is that the labor market is a lagging indicator, and that slower business activity will eventually generate cracks in the jobs market that cause the consumer sector to buckle; indeed, the pace of hiring has already slowed from the average of 223,000 per month recorded last year. But at the same time, slower jobs growth need not be a sign of economic weakness if it reflects an economy close to full employment.
Against this uncertain outlook, the Federal Reserve as expected cut interest rates by 25 bps in September – the second cut of the year – leaving the Fed Funds target range at 1.75-2.00%. The move was however interpreted as somewhat ‘hawkish’, with two out of 10 members voting for no cut (though one supported a larger 50 bps reduction), and the bank’s ‘dot plot’ projections pointing to no further rate cuts in 2019-20. It also left its forecasts for growth and infl ation next year, at 2.0% and 1.9% respectively, unchanged, implying no strong need for further policy action.
Markets however continue to take a different view, pricing in an 85% chance of at least one further cut by end year (probably October). The Fed has also been tackling a sudden and unexplained liquidity shortage in the money markets, which saw interbank interest rates temporarily spike in mid–September and resulted in the bank offering emergency short-term loans. These injections saw the Fed’s balance sheet record its first meaningful rise since it halted its quantitative easing program in 2014, with some analysts dubbing it ‘QE lite’.
The Fed in October then outlined a larger program of purchases of $60 billion per month of short-term treasury bills through 2Q20. Manufacturing gloom deepens amid ECB policy clash News on the Eurozone economy has become still more downbeat, with manufacturing in decline in most of the region and growing signs of spillover effects on the until recently more upbeat service sector. Germany’s manufacturing PMI plunged to a 10-year low of 41.7 in September amid investment cuts and accelerated job losses on the back of slower trade and Brexit-related uncertainty. The broader composite PMI at 48.5, saw its first sub-50 reading since 2013 and points to a decline in GDP in Q3 that would put the economy in recession following a 0.1% q/q contraction in Q2.
Equivalent results for the Eurozone as a whole (50.1) point to economic stagnation at the end of Q3, presenting the risk of a fall into recession if momentum continues to weaken going forward. Despite this worrying outlook, a degree of opposition surrounded the European Central Bank’s (ECB) loosening of monetary policy in September. The bank announced a package of easing policies, cutting the deposit rate to -0.5% and restarting its asset purchase program from November.
The move drew rare public criticism from some current and former ECB officials, who see ‘ultra loose’ policy as threatening financial stability, a backdoor attempt to finance highly indebted governments and also unjustified in the absence of a clear defl ationary threat (infl ation has been at 1% or higher for the past three years). The controversy could set the stage for a battle when Christine Lagarde replaces Mario Draghi as ECB president in November. This is important, as the bank’s perceived commitment to looser policy could be key in transmitting its effects through the markets
Report prepared by NBK