Oct 4, 2019

Axios Markets

By Dion Rabouin
Dion Rabouin

Heads-up: Every quarter Axios journalists highlight the trends we're watching in politics, energy, science, technology, business and more. As an Axios Markets subscriber, you'll see that in your inbox from Mike Allen tomorrow.

Situational awareness:

  • Economists are bracing for a downbeat U.S. jobs report, predicting the economy added just 130,000 jobs last month, the weakest forecast in 7 years, outside of months affected by major storms or the U.S. government shutdown. (Bloomberg)
  • A California city is drafting a law that would guarantee Uber and Lyft drivers a minimum of $30 an hour, or $15 an hour after gas and maintenance. (Fast Company)
  • American poverty is moving from cities to the suburbs, and the poor are increasingly likely to be white or Hispanic. (The Economist)
1 big thing: The upcoming U.S.-China trade talks are huge

Illustration: Aïda Amer/Axios

Investors will be closely watching today's U.S. nonfarm payrolls report, but they will also have one eye out for news on a potentially pivotal meeting between U.S. and Chinese negotiators next week.

What's happening: President Trump downplayed the importance of the meeting on Thursday, telling reporters he has "a lot of options on China. But if they don’t do what we want, we have tremendous power."

  • It's becoming clear the market doesn't see it that way.

Reality check: The U.S. economy continues to grow, but is increasingly struggling to do so. By the day, more economic indicators — from manufacturing to consumer and business sentiment and now the all-important services sector — are turning negative with more industries beginning to follow manufacturing, trade and transportation into outright contractions.

  • The trade talks are "the main concern" Bernard Baumohl, chief global economist at The Economic Outlook Group, has about the stock market.
  • "If once again nothing gets accomplished we could see another substantial fall," he tells Axios.

Where it stands: U.S. equities rebounded on Thursday, as traders continued to buy the dip despite data showing growth in the U.S. services sector badly missed expectations.

  • Investors increased bets that the Fed would step in next month with rate cuts to help stabilize the economy.
  • However, many are losing faith in the power of monetary policy to help steady the ship, especially in light of the continued struggles in the eurozone and Japan, which have instituted negative interest rates and considerable stimulus.

"Monetary policy is not going to do a damn thing," Baumohl says. "Monetary policy is being held hostage to this trade conflict."

But, but, but: There may be nothing Trump can do to get a meaningful deal with China at this point, as Beijing seems to be participating in negotiations "with the primary intention of staving off further tariff hikes,” Eleanor Olcott, China policy analyst at independent consultancy TS Lombard told the South China Morning Post.

  • “Trump’s actions throughout the trade war, escalating tensions in a wildly unpredictable manner, has made the US an unreliable negotiating partner in the eyes of the Chinese political elite. This, in turn, has relieved pressure on Xi to strike a deal because he is able to convincingly lay the blame for derailment on the US."
  • “The impeachment proceedings tie Trump’s hands when it comes to his domestic agenda, so his attention will be focused on his foreign policy stance, meaning we are likely entering a period of more volatile trade war news.”
2. Services data is following manufacturing
Expand chart

Data: Institute for Supply Management; Chart: Axios Visuals

Bullish market analysts and money managers have been somewhat dismissive of deteriorating manufacturing data this year and its importance, arguing that the sector makes up a minute portion of the U.S. economy.

While that is true, manufacturing is a leading indicator and more bearish investors have insisted the sector's decline would drag the rest of the economy down with it.

Threat level: The U.S. services sector, tracked by the ISM non-manufacturing index, clearly has been following manufacturing lower this year, with Thursday's report showing the sector at its weakest in 3 years.

  • As a service-oriented economy, the non-manufacturing sector makes up around 70% of America's growth engine, so the report's downward trajectory is a clear sign of distress.

Details: BMO Capital Markets VP of U.S. rates strategy Jon Hill points out that the index's imports component fell into contraction and both the new orders and inventories segments fell notably.

  • Services employment dropped to the weakest since February 2014 and the second-lowest since July 2012.
  • ISM's report also noted that "respondents are mostly concerned about tariffs, labor resources and the direction of the economy," eerily similar to comments reported in the manufacturing survey for much of the year.

The big picture: "This, when taken with the revised [IHS Markit U.S. PMI] release ... that showed services jobs declining for the first time since 2010, indicates that some cracks in the non-factory component of the economy are beginning to widen," Hill said in a note to clients.

3. The market is now almost certain the Fed will cut rates this month
Expand chart

Data: CME Group; Chart: Axios Visuals

Fed fund futures prices last week showed the market saw about a 50/50 chance the Fed would cut interest rates at this month's policy meeting.

  • Following the release of the ISM's manufacturing report on Tuesday that showed the weakest reading since 2009 and the non-manufacturing report on Thursday, expectations have shot to a near certainty that a rate cut is coming, according to CME Group's FedWatch tool.
  • Expectations for a cut in December rose to 50% on Thursday.

What to watch: A weak reading on today's nonfarm payrolls report will likely send expectations to near 100% for October and above 60% for December.

4. The yield curve has steepened for all the wrong reasons
Expand chart

Data: Federal Reserve Bank of St. Louis; Chart: Axios Visuals

The U.S. Treasury yield curve is steepening, which typically means investors are growing more confident about the economy. However, analysts say recent moves are actually the result of more fear being priced into the market.

Why it matters: Rather than bets U.S. growth or inflation will pick up, as is the case when the curve sees "bull steepening," action in the Treasury market reflects worry that things could get especially bad in the short term, Tom Essaye, president of Sevens Report Research, tells Axios.

  • "That's not a good thing."

Details: Investors saw fresh cracks in the U.S. economy from both the ISM manufacturing and non-manufacturing reports this week, as well as declines in private payroll growth from ADP and an increase in the number of Americans filing for unemployment benefits amid GM's auto workers strike.

  • The poor data also pulls forward expectations that the Fed will have to cut U.S. interest rates at its next meeting and again in December.

What they're saying: "Earlier this week it was a coin flip on whether or not the Fed was going to cut rates this month or in December, but the ISM and ISM non-mfg changed the odds quite significantly in a short amount of time," DRW Trading market strategist Lou Brien tells Axios in an email.

The big picture: While the Fed has qualified its 2 rate cuts this year as "midcycle adjustments," having to lower rates at its next 2 meetings "would be the Fed’s worst fears coming true," Brien says, signaling a much worse state of play for the U.S. economy.

Of note: The 3-month/10-year yield curve that economists call the best predictor of a recession remains inverted by a wide margin, and 1-month T-bill yields have ticked up to 24 basis points above those on the 10-year.

Dion Rabouin

Was this email forwarded to you? Sign up here.