The second largest drop in US equities this year has spilled over to drag
global markets lower. The MSCI Asia Pacific Index fell nearly 0.5%,
snapping a four-day advance and cutting this week’s gain in half. The Dow
Jones Stoxx did not completely escape the US carnage yesterday, but losses are
accelerating today, with a nearly 1% decline following a 0.6% decline
yesterday.
Despite the better than expected retail sales figures earlier in the
week, US yields have fallen this week. The 10-year yield is back below 2.20%, off four basis points.
Today’s yield two-three basis points decline in European bonds leaves most bond
markets (except Spain) little changed on
the week.
A combination of the terrorist strike in Spain and developments in
Washington are cited as the major drivers
of the slide in US equities, which was seen
in the consensus view as a trigger to the
dollar and drop in yields. Such explanations are surely part of it,
but we would also underscore the importance of what the Fed said in the
minutes. We cited it yesterday, but think
is so important, we repeat it today: “vulnerabilities
associated with asset valuation pressures edged up from notable to
elevated.” The
Fed upgraded its concern about asset prices (read stock market and long-term
bonds). The following the day the stock market sells off and yet few draw
a connection.
The US political tension escalated importantly
this week that is potentially important for investors. Up until now,
it seemed that the leadership of the large US companies were willing to work
with the new president, despite his unorthodox ways. The economic agenda,
tax reform, deregulation, and infrastructure initiative had much to commend
itself to them.
However, what has happened in recent days, is that the national
bourgeoisie wing of the coalition has begun defecting. That part of
the reason that rumors of NEC Director Cohn stepping down elicited such a
strong market response. Confidence that Trump’s economic agenda
will be implemented has waned in recent
months, as the health care reform floundered, and one drama or another
distracted. We did not emphasize Trump’s declining support as a market
factor because his base held. There are signs of it cracking.
Heightened policy uncertainty may not be conducive to the investment climate
and the same moment the Fed raises the decibel of its warning about asset prices.
The news stream is light and activity is winding down for the
weekend. The North American session features the University of
Michigan’s consumer sentiment survey and inflation expectations. It will be
the preliminary August reading. Unless there is a large move in sentiment
survey, the most important part of the report is the long-term inflation
expectations. Recall that the 5-10 year expectation finished 2016 at
2.3%. After it rose to 2.6% in January, it eased and as recently as May
was at 2.4%. However, it rose in June and July to return to 2.6%.
It has not been above it since March 2016.
Canada reports its July CPI data today. Headline inflation,
which has fallen from 2.1% in January to 1.0% in June, is expected to
rise for the first time this year (to 1.2%). The underlying measures run
a little higher than the headline. Extrapolating from the OIS, market
expectations for an October hike (there is a Bank of Canada meeting on
September 6, but that is not the focus given the July rate hike) have been very
stable around 50% over the past month. Investors may be more sensitive
to a weaker rather than a stronger report.
The euro is trading within yesterday’s widest range in nearly two weeks.
The euro has spent most of the week below the 20-day moving average (~$1.1760)
since the second half of June. A series of lower highs creates a down
trend line that comes in today a little above $1.18, and $1.1760 in a week’s
time. After reaching almost JPY111 in the middle of the week, the
combination of developments saw it briefly slip below JPY109.00. A week
ago, the greenback made a low nearer JPY108.75. Our work continues to
show a strong correlation between the change in US interest rates and changes
in the dollar-yen exchange rate.
We note two emerging market developments. First, Taiwan
upgraded it economic outlook for this year and next. The anticipation of
stronger exports was key. This is
not just about Taiwan. Global trade
appears to be improving after being sluggish post-crisis. While many
economists understand how trade can increase growth, it has become clearer that
stronger growth also facilitates trade. Second, China’s Shanghai
Composite posted its biggest advance (~1.9%) in four months, though was little
changed today. Separately, China announced it would restrict domestic companies from
investing in real estate, hotels, entertainment and sports clubs.
Overseas investing in gambling will also be banned.