According to Bloomberg Economics published just a few days ago, there is now only a 27% probability that the US will go into a recession within the next 12 months.
It further added that while this remains as a warning sign, there’s no need to panic just yet and the chances of a recession, although higher than they were at the start of the year, is now lower than they were over the summer period and before previous downturns. So what has changed over the past couple of months?
Well, firstly, the beating of drums of trade war has slowly subsided and this is perhaps the single largest reason for some sort of confidence to return to markets as the US President has postponed the implementation of the Oct 15 tariff hike from 25% to 30% on US$250bil worth of Chinese imports while in return, China will at least buy US$20bil of agricultural products in a year if it signs a partial trade deal with the US and would even consider boosting its US agriculture produce purchases further in future rounds of talks.
Secondly, about a month ago, we saw the disruption in the US overnight money market rate.
The rate on the overnight general collateral repurchase agreements soared by more than 600 basis points to 8.75% as banks simply ran out of cash reserves due to unscheduled payments drawdowns. This invited the Fed to provide the much needed liquidity to ensure that the market normalises as a prolong squeeze could have significant impact on the banking sector as well as the financial markets as whole, especially when the Fed Fund rate at that time was between 2% and 2.25%.
Third point. Market’s sentiment also improved as investors got the right tonic from the Fed when it kick-started another quantitative easing (QE) programme. The Fed did not coin this two-letter acronym this time around for fear of getting the backlash of the market due to the negative connotation that it could lead to market questioning Fed’s intentions.
This is indeed a departure from just a few months ago when the Fed halted shrinking its balance sheet and now its back to its 2008-2014 balance sheet expansion via the various QE programmes. In September alone, the Fed expanded its balance sheet to the tune of US$253bil in just 42 days, mainly due to the shortage in the short term money market funds.
However, the Fed will also expand its balance sheet via purchase of US Treasuries of up to US$60bil a month, which started on Oct 15, and well into at least Q2 of 2020. That would easily add another close to half a trillion dollars into the over-expanded Fed’s balance sheet which presently stand at about US$4.01 trillion.
Effectively, the Fed would completely turn the tables on its previous quantitative tightening measures and surpass the US$4.5 trillion peak reached previously in terms of the size of its balance sheet.
Fourthly, is the Fed’s stance on rates. While the US President thinks that the Fed should cut as much as 100bps to help the economy and to reduce the rate disparity between the US and the EU, the Fed has only moved twice this year and the best part, more than the Fed itself thinks it should have done.
The Fed has in fact been a reluctant proponent of lower rates but market thinks otherwise. For now, the market is more than 90% sure that the Fed will cut the US benchmark rates by another 25bps by end of this month – the third consecutive cut, that will take US Fed fund rate to between 1.5-1.75%.
What’s next after this month’s cut? Well, the Fed has not laid out the direction going forward just yet while the market too has moved away from its earlier prediction of a December 2020 rate cut. Hence, the window is now wide open as to the next Fed’s move while the market, for once, thinks the Fed is right.
With this, we are seeing interesting movement in the fixed income market as the 2-year and 10-year US treasuries having moved up back by about 20 bps and 30bps since the September lows to 1.57% and 1.75% respectively.
But, the 3-months US Treasuries remained very strong with the yield today at just 1.65%, down by more than 35bps from its level two months ago.
This pick-up in yield on the medium to long end but drop in the shorter end has caused the long inverted 10-year less 3-month has un-inverted and its back to positive territory.
And, guess what? We are getting back into a steepening yield curve as yields on the long-end is too rising in tandem with the overall shift in sentiment.
The fifth point is our fixation of the weak economic data points. Starting out with the slower than expected China’s 3Q GDP and weaker than expected jobs in the US labour market, slower wage growth, despite the near 40-year low of the US unemployment figure.
PMI indicators too are all flashing red with only some pockets of hope while headline inflation remains a threat in the US as well as China. Across the Atlantic, we still have Brexit on the table, likely in another three months’ time, as the UK Parliament needs more time to debate the deal brokered by the Prime Minister with the EU. The potential UK polls in December too is now not ruled out as Prime Minister Boris Johnson is eager to get Brexit done.
Asia remains the beacon of hope for the rest of the world but that too is expected to be slower than before. IMF, in its recent assessment of the global economy, has lowered the global growth outlook by 0.1 and 0.2 percentage points for this year and next year to 3% and 3.4% respectively.
One of the key drivers of this pessimistic view is the on-going US-China trade war which IMF believes could knock off as much as 0.8 percentage points in global GDP in 2020. In fact, based on IMF’s projections, the US, Japan and China are expected to see a slower growth next year than this year by between 0.3-0.4 percentage points while other economies globally are expected to grow by between 0.1 to as much as two percentage points.
So what does all these mixed signals mean for markets?
For once, the market just loves more money! As can be seen, the Dow and the S&P500 recently came close to hit its recent record highs set in July.
Gold prices are off slightly from the recent peak as the US dollar has weakened again, implying flight to safety is no longer needed, while bets on market is rising as investors embraced riskier options to generate that extra market returns.
Indeed, the market is as tricky as it can get with so many moving parts. But once all the parts that sum up where the market is headed, we would probably have a better picture in terms of its direction in the near and short-term.
For now, its still a mixed signal and tilting towards the positive and the market has taken the good news to celebrate and not focus on the negative data points. After all, its time to let the music play on as the Fed is now committed to provide the liquidity that drives market sentiment. So, while the economies are not expecting to turn the corner just yet, markets are moving towards that direction.
The views expressed here are the writer’s own.
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