(Bloomberg Opinion) -- There’s still plenty of time for things to go off the rails, but 2019 is shaping up to be one of those rare years when the global stock, bond, commodities and foreign-exchange markets are all poised to deliver positive returns. The last time that happened was in 2010. Investors say three things would keep the good times rolling; unfortunately, two of those items are unlikely to happen, starting with the Federal Reserve’s monetary policy decision on Wednesday.
The latest monthly survey of global fund managers by Bank of America Merrill Lynch found that German fiscal stimulus, a 50-basis-point rate cut by the Fed and Chinese infrastructure spending would be the most bullish policies for risk assets over the next six months. But the famously austere Germans look hesitant to fend off a slowdown in Europe’s largest economy just by spending. Finance Minister Olaf Scholz said last week that Germany would stick to a balanced budget, but was ready to act in moments of crisis. As for the Fed, the odds that policy makers on Wednesday will announce a half-point cut in their target rate for overnight loans between banks instead of a quarter-point reduction has shrunk to less than 15% from more than 40% last month. This follows a string of data showing that, thanks to the consumer, the U.S. economy is holding up pretty well amidst the ongoing trade war with China. There are even some economists and strategists, such as those at Brown Brothers Harriman, who say the Fed maybe doesn’t need to lower rates at all this time. The most likely scenario is that the central bank will ease monetary policy on Wednesday, while saying any further loosening will depend on the data, which is something that isn’t exactly priced into markets. “There is a risk that absent a strong signal that the Fed is clearly at the beginning of a sustained easing cycle, we could see some disappointment,” BNY Mellon strategist John Velis wrote in a research note Tuesday.
So if the Germans and the Fed disappoint, that leaves the heavy lifting to China. Here, though, there is some good news. Bloomberg News reported last month that China is considering allowing provincial governments to issue more bonds for infrastructure investment. Policy makers may raise the annual quota for so-called special bonds from the current level of 2.15 trillion yuan ($305 billion), Bloomberg News reported, citing people familiar with the situation who asked not to be named as the matter wasn’t yet public.
OIL MARKETS HAVE A DEEP THROATOne day after soaring almost 15% following an attack that wiped out about half of Saudi Arabia’s output capacity, oil plunged as much as 7% as Reuters reported the kingdom’s output will be fully back on line in the next two to three weeks, which is much sooner than the months some expected it would take. No matter that Reuters cited one unidentified Saudi source who was briefed on the timeline – traders wanted to believe. It helped that Saudi officials later confirmed that at least one of the damaged facilities will be back to producing oil at pre-attack levels by the end of the month. However, oil traders might be wise to be a bit more skeptical. It’s not crazy to think that Saudi officials would want to downplay the success of the strikes at a time when its military is getting a lot of criticism for not detecting and stopping whatever it was that crippled the facilities. “We flip from worst case scenario to best case scenario in less than 24 hours,” John Kilduff, a partner at Again Capital LLC, told Bloomberg News. “We still need damage assessments and what it takes for those repairs.”
CAN’T SPELL FUNDING WITHOUT ‘FUN’The repurchase, or repo, market went haywire for a second straight day on Tuesday, forcing the Fed to inject billions of dollars of cash into the system for the first time in a decade to temper a surge in short-term rates. All of this sounds concerning, especially since the financial crisis was partly exacerbated by a seizing up of the funding market. But that’s not what’s happening here. Market participants say the spike in short-term rates is a result mainly of a confluence of technical events, including the sudden withdrawal of cash from money-market funds by companies needing to pay taxes. But there are still reasons to be concerned. The first is that this all comes with the new York Fed still without a formal head of its markets group following the abrupt departure of the widely respected Simon Potter earlier this year. The implication is that if Potter were still around, traders at the central bank might have been better prepared to handle any unforeseen stresses in funding markets. The second reason for concern is that the move in the repo market has definitely had some knock-on effects, especially in overnight bank funding costs. Those reached 45 basis points Monday before easing to 41.9 basis points Tuesday, levels that are more in line with times of broad market turbulence. Bank earnings are already under pressure from a flat yield curve, and this spike in funding cost won’t help, which may explain why the KBW Bank Index fell the most in more than two weeks on Tuesday.
SHAKING THE BEARS OUTTo say it hasn’t been a good month for the U.S. Treasury market would be an understatement. The Bloomberg Barclays U.S. Treasury Index was down 1.96% in September through Monday, putting the benchmark on track for its worst monthly performance since it dropped 2.67% in November 2016 following President Donald Trump’s election victory. The swift decline has many wondering whether the bond market is at the beginning of a sustained turn for the worse. The evidence, though, suggests the move has been more about positioning than anything fundamental. That is seen in the Bank of America survey. For the second straight month, it found that being “long” Treasuries was the most crowded trade in global markets, followed by being “long” technology and growth stocks and being “long” gold. So, with so many investors and traders leaning one way, it doesn’t take much for a move in the opposite direction to force traders to rebalance. On the positive side, JPMorgan Chase & Co.’s widely followed weekly survey of bond traders released on Tuesday suggested that the sell-off may be ending. Its index tracking clients who are “short” is back near its lowest level since 2016, suggesting all those who want to bet against the bond market have already done so.
EARNINGS DON’T MATTERThe latest Bloomberg News survey of where Wall Street strategists expect the S&P 500 to end the year came out on Tuesday, and the results confirm just how reliant equities are on low interest rates. It’s not so much that strategists see the S&P 500 ending the year at 3,000, or little changed from current levels; it’s that they expect equities to be resilient in the face of ever lower profit forecasts. They now forecast 2019 earnings per share of $166.35 for the gauge, down from their estimate of $172.25 at the start of the year. Also back then, the strategists we’re only expecting the S&P 500 to end the year at 2,913. So they’ve raised their forecasts for how high the index will go while also cutting their earnings estimates. That may seem counter-intuitive, until you consider that simple discounted cash-flow analysis shows how lower rates make future earnings more valuable now, justifying higher multiples for equities even without profit growth. So, logic would dictate that the lower rates go, the better for equities. This makes Wednesday’s Fed meeting all the more important for equities, especially with the S&P 500 trading at about 18.2 times this year’s expected earnings, which is the highest since January 2018.
TEA LEAVESA big drop in mortgage rates is giving new life to the U.S. housing market despite a slowing economy. The National Association of Home Builders/Wells Fargo Housing Market Index released on Tuesday increased to 68 in September from an upwardly revised 67 in August. The current level is at an 11-month high. Also on Tuesday, the Mortgage Bankers Association said its data show that mortgage applications for new home purchases increased 33% in August from a year earlier. Both reports are good omens for Wednesday’s government report on housing starts and permits. The median estimate of economists surveyed by Bloomberg is for starts to have rebounded 5% in August after falling 4% in July. Permits are seen declining 1.3%, but that shouldn’t be worrisome after July’s outsized 6.9% gain, which was the biggest since 2017.
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Robert Burgess is an editor for Bloomberg Opinion. He is the former global executive editor in charge of financial markets for Bloomberg News. As managing editor, he led the company’s news coverage of credit markets during the global financial crisis.
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