European markets went out at the lows of the day as bond market weakness particularly with Italy and Spain was glaring. The Italian 10 yr yield, as seen in the chart I sent this morning, is now up by 37 bps over the past week. It’s up by 9 bps today to 1.75%. The Spanish 10 yr yield got dragged up by 10 bps today to 1.30%. The French 10 yr yield was up by 3 bps to .50% and is now above the June 23rd close the day of the UK vote. The 10 yr bund yield closed at the highest since late May. European banks, loaded up with sovereign bonds, are closed down 1.6% after yesterday’s 1.3% drop.
In the US, Treasury yields rose intra-day and the credit weakness spilled over into high yield and investment grade. The 5 yr high yield CDS index was wider by 5.5 bps to the widest since early July. HYG, the high yield etf, broke below its 100 day moving average and is down for the 6th straight day. LQD, the investment grade etf, is traded at the weakest level since early June and is about to test its 200 day moving average.
Can this also be a post ‘James Comey FBI poll bounce for Trump’ selloff? Maybe but I argue the movement in interest rates is many more times important for markets after the election and heading into 2017 than who the next President will be.
The ISM manufacturing October index was 51.9, a touch above the estimate of 51.7 and up from 51.5 in September. This brings the 3 month average to 50.9, the 6 month average to 51.7 and the 12 month average to 50.6. Notwithstanding the gain in the headline figure, the internals were pretty mixed. New orders fell 3 pts to 52.1 after rising by 6 pts in September with just 8 of 18 industries seeing growth. Backlogs fell 4 pts to 45.5 after rising by the same amount last month. That is the weakest level since January. Inventories at both the manufacturer and customer levels fell m/o/m and both are below 50. Employment was a bright spot, rising by 3.2 pts to 52.9 which is the first time above 50 since June 2015 with 11 of 18 industries adding workers. Export orders were steady at 52.5 vs 52 in September and 52.5 in August and July. But, just 6 industries of 18 surveyed saw export growth. Prices paid rose 1.5 pts to 54.5 but still remains below its 6 month average of 56.6. Of the 18 industries surveyed, 10 saw growth vs 7 that said the same in September. Eight saw a contraction vs 11 last month.
The ISM is looking at the glass as mostly half full by saying “Comments from the panel are largely positive citing a favorable economy and steady sales, with some exceptions.” Bottom line, US manufacturing continues to muddle along with modest gains. Manufacturers face the challenge of modest global trade growth but also the volatility in the US dollar. Looking back over the past year saw manufacturing contraction in late 2015 into early 2016 coincident with the sharp rise in the US dollar. The ISM got back above 50 in the spring and summer months when the dollar fell but has held above even with the recent rally in the dollar. A factor in helping to stabilize manufacturing seems to be the stabilization in commodity prices which helps those involved in its production and processing including the machinery used to do so.
Construction spending in September fell .4% m/o/m instead of rising by .5% as expected. A large 10% drop in public residential construction was the key culprit but private commercial real estate construction also fell by 1% only partially offset by a .5% rise in private residential real estate. I’ll say this about CRE construction, try getting a construction loan from a bank nowadays. Good luck. Most builders have no choice but to get it from non traditional lenders at much higher rates.
In China, the state sector weighted manufacturing PMI rose .8 pts to 51.2 vs the estimate of 50.3. While barely above 50 it is at the best level since July 2014 driven mainly by output and new orders. Employment was up a hair but still below 50 and export orders fell almost 1 pt to back below 50. Thus, we can surmise that much of the improvement was internal and therefore stimulus driven. Inflation pressures came with it as Input Prices rose 5 pts to the most since April 2011 due to the rise in commodity prices.
The China services PMI was up a touch to 54 from 53.7 in September. Interestingly, here is where export orders rose above 50 but there aren’t many services that China exports. As for the Chinese private sector, the Caixin manufacturing PMI rose 1.1 pts to 51.2, above the estimate of 50.1. Here, the improvement was also domestically based as export sales fell. Prices pressures were also felt as “Chinese manufacturers signaled a sharp and accelerated increase in average cost burdens.” To my point on stimulus based stabilization, Caixin said “The economy seems to be stabilizing for the moment, owing primarily to policies implemented to sustain growth.” China remains in this internal paradox of wanting to deleverage at the same time they are encouraging leverage in order to boost growth. Recently, the leverage has been more of a shell game in that its shifting to the household away from the corporate sector. Chinese stocks rallied on the data and the yuan was higher.
Manufacturing PMI’s in Indonesia, Malaysia, Vietnam and Japan all fell m/o/m. They remained unchanged but below 50 in Thailand and South Korea’s PMI was up .4 pts but stuck below 50 at 48. India is where notable improvement took place as their index rose 2.3 pts to 54.4, the highest since December 2014. Also of note and directly influenced by the China slowdown, South Korean exports in October shrunk by 3.2% y/o/y, about in line with the forecast but the 21st month in the past 22 that has seen declines.
We’ll see an updated Eurozone manufacturing PMI tomorrow. The UK’s PMI index fell to 54.3 from 55.5 which was a 2 yr high. The economic give and take of a weaker pound was clearly evident as input costs rose as did export orders. Input prices had “one of the steepest rises in purchasing costs in the near 25 yr survey history. Around 90% of companies offering a reason for increased costs made some reference to the sterling exchange rate.” In an attempt to pass on these higher costs saw “average selling prices rising at the steepest pace since mid 2011.” While the BoE is about to get what it wants in higher inflation, it will be proven to be a drag on growth and consumer well being that will offset any gains from exports. The 10 yr Gilt yield is hovering around its highest level since the June 23rd vote. The pound is flat but 5 yr UK inflation breakevens are busting out to the most since April 2013.
The BoJ did nothing as expected. Kuroda is waving the white flag on additional action and has his betting chips on yield curve control out to 10 years. He is giving banks a whopping 10 bps of a curve. As for maturities past that, “Super long yields may move up and down along with expectations for the economy and prices, but should be determined by the market.” Considering the mammoth amount of market intervention and manipulation from the BoJ over the years, Kuroda is finally leaving something to the market but he still can’t shake his fear of deflation. He said today “deflation can never be good.” It’s a nonsense comment as ask anyone that has gone shopping or has bought a technology product. There is also something called ‘economies of scale’ that he is ignoring where business gets more efficient. As for getting to his preferred 2% inflation target, he acknowledged that he now has no idea when. It was the mid 1990’s the last time that Japan had sustainable wage gains above 2% so let’s hope they don’t achieve 2% inflation. Japan’s 10 yr inflation breakeven is at .40%, the most since early June. The yen is down slightly, the Nikkei was little changed as were JGB yields.
Lastly, I include a chart of the Italian 10 yr yield in the context of global sovereign bond weakness and ahead of the December 4th referendum: