The Weekly Update

USD 10-year Treasuries rallied 15 basis points to 2.44% last week following rekindled growth concerns and the Fed’s further back-pedalling on last December’s rate hike. On Friday, a sharp -1.9% fall in the S&P 500 more than unwound earlier gains to close the week down -0.8%. Adding to the unsettledness was the media-attention-grabbing inversion of the US Treasury yield curve between the 3-month and 10-year marks, which has historically had a strong correlation with a coming recession (leading from a few months to a few years). Europe made sure that markets were sufficiently spooked adding a swathe of weak data, from German manufacturing to Eurozone PMI,  ultimately leading to negative yields on 10-year Bunds. Meanwhile the UK staved off catastrophe for at least a couple of weeks as the EU agreed to extend the date for Brexit to 12th April, or 22nd May if the UK can coalesce around a compromising position.

The “patient” and dovish forward guidance from the Fed in January was firmly delineated in the latest Fed meeting rate forecasts; this is about as far as the Fed could go in admitting that raising rates in December was a policy error without actually cutting rates. The shift can be seen most clearly in the 2019 and 2020 dot plot for the Implied Fed Funds Target Rate – which fell a full-half percentage point from 3.125% and 2.875% in December to 2.625% and 2.375% now. For 2020 forcasts, an overwhelming 11 of the current 17 FOMC members now anticipate levels around 2.5% (2.375% or 2.625%) compared to just 2 members in December. Bloomberg is estimating over two-thirds implied probability of a rate cut within the next 12 months. Some Fed commentators argue that they should cut sooner as an insurance policy and expect a rational Fed (more concerned with data than politics) would act as such it if there were any further signs of slower growth. Last week’s meeting demonstrated a seismic shift: if indeed the Fed now is willing to believe that unemployment below the natural rate does not necessarily place significant pressure on inflation. Such a stance would set the bar for inflationary concern and a rate hike much higher.

In Europe, economic weaknesses and market concerns were evident beyond fears of a no-deal Brexit and the potential for a tariff war with the US; disappointing data reflected various headwinds from slowing trade with China (although Germany as a whole narrowly avoided recession last quarter its manufacturing sector is clearly contracting) to growing effects of the region’s underinvestment in technological innovation. All these factors combined led to the steepest decline in Germany’s IHS Markit Manufacturing Index in over 6 years. Phil Smith, their principal economist warned, “Most worrying is the plight of the manufacturing sector, which is now in its deepest downturn since 2013 as trade flows contracted at the sharpest rate since the debt crisis ridden days of 2012” expecting even weaker growth in the second quarter and possible “doubts on the economy’s ability to grow by more than 1% in 2019.”

In the week ahead, starting today we have IFO business climate, the Chicago Fed National Activity Index and Dallas Fed Manufacturing Index. On Tuesday it’s Germany GFK consumer confidence and France business confidence; France consumer confidence and PPI out on Wednesday, along with China industrial profits and US trade balance. Eurozone wide business confidence and Germany CPI data will be in focus on Thursday. On Friday Japan industrial production, retail sales and unemployment data are released, as are UK consumer confidence and Germany retail sales.

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