(Bloomberg Opinion) -- Following the gut-wrenching sell-off in stocks at the end of 2018 that put most indexes on the cusp of a bear market, President Donald Trump said the market was just suffering “a little glitch” that would soon correct itself. He was right, as the market staged a record-setting rebound – that is, until the declines of the past few weeks. Now, after a big drop on Thursday, the S&P 500 Index is on pace for its first losing month of the year, and this time there’s reason to believe this is no glitch, but something more serious.
Back during the prior market downturn, there was still hope that a trade war between the U.S and China would be averted. Plus, reports from the manufacturing sector were upbeat. This month, however, mounting trade tensions have put the prospect of an agreement on ice , with the battle lines hardening in recent days. As for the economy, we found out on Thursday that factory activity is slowing to dangerous levels. The preliminary U.S. manufacturing purchasing managers' index from IHS Markit fell two points to 50.6, the lowest reading in a decade. The drop was led by the new-orders gauge, which showed a contraction for the first time since August 2009. The factory report lends credence to the notion that the primary reason for the better-than-expected gross domestic product report in the first quarter was companies front-loading orders in anticipation of the escalating trade war. What’s even more jarring about the IHS Markit report is that its overall composite index – which combines manufacturing and services – is now below the euro zone’s gauge.
Although stocks opened the day lower, they were in recovery mode until the IHS Markit report hit. They then reversed and dropped to their lows of the day. Stock bulls had the wind at their backs through the first four months of the year, thanks to the dovish pivot by the Federal Reserve, more reasonable valuations following the December slide and steady pronouncements by the White House that a trade deal was nigh. But now, “all three catalysts have been actualized, with the last of the three now having taken a turn for the worse,” strategists at Cantor Fitzgerald wrote in a research note. So, what might be the catalyst to reverse the slide in equities? “We don’t see any, especially as global growth continues to roll over,” the Cantor strategists added.
SELF-FULFILLING PROPHECY?The IHS Markit report also had an effect on the bond market, helping to push yields on U.S. Treasuries to their lowest since 2017. Bond traders are clearly expecting the Fed to cut rates sooner rather than later. Futures show the probability of a rate decrease at the Fed’s September meeting has more than doubled to 56% from 25% in April, data compiled by Bloomberg show. That may be hard to believe with the unemployment rate at its lowest since 1969, but history shows that unemployment is typically its lowest right before a recession. What’s more likely to get the Fed to cut rates is inflation and inflation expectations. Both are trending lower and further away from the central bank’s 2% target. Breakeven rates on five-year U.S. Treasuries – a measure of what bond traders expect the rate of inflation to be over the life of the securities – fell to as low as 1.61% Thursday, the lowest level since early January. The rate was around 1.90% as recently as March. The Fed views expectations for falling prices as something of a self-fulfilling prophecy, in that if markets and consumers expect slower inflation, it will likely happen. One way to reverse this momentum is by cutting rates. “The precipitous drop in inflation compensation could portend a change in mood” at the Fed, “opening the door for cuts earlier than previously assumed,” Jon Hill, a rates strategist at BMO Capital Markets, wrote in a research note.
NO HAVENThe greenback was on its way toward another winning day, with the Bloomberg Dollar Spot Index reaching a new high for the year. But the IHS Markit report put a stop to that, causing the gauge to quickly reverse and fall into the red for the day even as those other currency havens, the yen and Swiss franc, soared. Yes, the dollar has had a good run the last couple of months and maybe traders were looking for an excuse to lighten their exposure, but to see weakness on a decidedly “risk-off” day in the global markets says something about how the international markets may be viewing the U.S. both economically and politically. The dollar’s reversal also came around the same time that House Speaker Nancy Pelosi took the highly unusual step of seeming to question the president’s mental fitness. "I wish that his family or his administration or staff would have an intervention for the good of the country," Pelosi said. "Maybe he wants to take a leave of absence." According to the Associated Press, when asked whether she's concerned about Trump's well-being, Pelosi replied, "I am." Politics is always a dirty business, but this generation of traders has never seen anything like this before. Increasing political uncertainty at a time when the economy slowing, deflation is a possibility and the Fed is expected to cut rates isn’t something that’s likely to appeal to currency traders.
CRUDE CRUMBLESThe jitters extended to the oil market, where prices plunged as much as 6.66% in their biggest slide this year. Prices are now down 13 percent from this year’s high reached a month ago. Traders are dealing with a double whammy of increasing U.S. supplies and a slowing global economy. The U.S. Energy Department said Wednesday that weekly American crude inventories swelled to the highest in almost two years. The day before, the Organization for Economic Cooperation and Development – which had already made big cuts to its global economic projections in March – did so again, trimming its 2019 forecast to 3.2% from 3.3%. “It seems like we’re going to be entrenched in a trade war, which is really going to hurt demand for crude oil,” Tariq Zahir, a commodity fund manager at Tyche Capital Advisors, told Bloomberg News. Of course, there is a silver lining: Lower oil prices should contain gasoline costs, supporting U.S. consumers heading into the summer driving season. Regular unleaded gasoline prices are currently $2.87 per gallon, but based on typical seasonal patterns, prices should plateau over the next several weeks and not exceed the $3 mark, according to Bloomberg Economics’s Carl Riccadonna. This kind of measured increased “should not pose a risk to consumption, but households are starting to take notice,” Riccadonna wrote in a research note Thursday. “It is becoming increasingly apparent that consumers will once again be the primary engine of economic growth in 2019.”
WHO’S REALLY PAYINGTrump often says that China is paying the costs of the U.S.-imposed tariffs. “For 10 months, China has been paying Tariffs to the USA of 25% on 50 Billion Dollars of High Tech, and 10% on 200 Billion Dollars of other goods,” Trump tweeted May 5. The highly authoritative International Monetary Fund released a blog post Thursday that attempted to set the record straight on just who is paying. Its findings leave no room for interpretation. “Tariff revenue collected has been borne almost entirely by U.S. importers,” the IMF said. “Some of these tariffs have been passed on to U.S. consumers, like those on washing machines, while others have been absorbed by importing firms through lower profit margins.” The thing to know about the IMF is that it’s basically owned by its member countries, with the U.S. having the largest stake. In that sense, it’s rare for the IMF to disagree with its largest shareholder, according to Bloomberg News’s Brendan Murray. According to a separate report Thursday from researchers at the Federal Reserve Bank of New York, the U.S.’s 15 percentage-point increase in tariffs will result in an annual cost of $831 per American household, about double the bill on Trump’s 2018 tariffs. And given that the Fed figures that almost 40% would struggle in the face of a $400 financial emergency, it’s easy to see why stock traders are worried about the fallout from the escalating trade war.
TEA LEAVESThe monthly U.S. durable goods report is notoriously volatile. Market participants generally ignore the headline number and drill down into the data for the part where such big-ticket items as planes and trains get excluded and focus on something called non-military capital goods orders excluding aircraft. This measure – which is a good proxy for business investment – rose 1.4 percent in March, but the government is expected to say it fell by 0.3 percent in April when it releases the latest monthly data Friday. Concern is growing that the escalating trade war is causing business executives to postpone spending and investment, which would weigh on economic growth. On top of that, many businesses front-loaded orders in the first quarter, anticipating no trade deal. If so, that could make April’s number especially bad.
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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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