With rate cut odds now where they are (62% by July and almost 100% of two this year by December), the euro heavy dollar index is at a 7 week low and gold is rising to a 15 week high. I do want to chime in on the Fed discussion about an ‘insurance rate cut’ because some members keep referring to the experience of 1995 and 1998. In 1995, the US economy was only in the 4th year of its expansion (trough of previous recession was March 1991) vs the current record of 10 years. The rate cuts in 1998 sowed the seeds for the greatest stock market bubble blow off we’ve ever seen. I remain of the belief that with only 9 rates to cut (and should be less because we should NEVER see zero rates again), the Fed needs to be really judicious with each one. Also, how will the Fed square an insurance cut (as opposed to one legitimately used to deal with a pronounced economic slowdown) with the expressed worries about excessive corporate debt that the era of extraordinarily low rates encouraged?
Whatever the Fed chooses to do I’ll point out again that the bond market has already eased aggressively. The 10 yr yield is down 110 bps from where it was last October. Mortgage rates in turn have fallen to near 4%. But, are we seeing signs that it just doesn’t matter at this point of the cycle and with rates already so low? Mortgage applications to buy a home fell by 2.4% w/o/w and that’s the 4th week in a row of declines. They are now flat y/o/y. For this important Spring season, I believe it is safe to say that the stimulus via lower mortgage rates was expecting to generate didn’t really show up much. Refi’s are the only place where it mattered as they grew by 6.4% w/o/w and 33% y/o/y.
MBA PURCHASE APPS
Ahead of the US services data today where we’ll see to what extent the weakness in manufacturing spills into the rest of the economy, we saw some service data points overseas. China’s private sector weighted May services PMI fell to 52.7 from 54.5 and that was below the estimate of 54. That’s the lowest since February and Markit said this when referring to both manufacturing and services, “Overall, China’s economic growth showed some signs of slowing in May. Employment and business confidence in particular merit policymakers’ attention.”
Also of note with China, Hong Kong’s May PMI fell to a 3 year low at just 46.9 from 48.4 in April. Markit said “Most concerning was a sharper contraction in new orders, led by lower demand from mainland China.” China accounts for more than half of Hong Kong’s total exports. Markit estimates economic growth for Hong Kong this year being less than 1.5%.
The Chinese stock market response to the data was very little as the Shanghai comp and H share index were flat but the Hang Seng closed up by .5%. At this point the slowdown is clear and the question is to what degree from here. A lot of course will depend on what comes next between Trump and Xi.
Japan’s services PMI fell for a 3rd straight month but by a modest .1 pt to 51.7. The concern for many service companies is the upcoming hike in the VAT. Markit said this figure “Taken in conjunction with the earlier released manufacturing PMI, private sector output in Japan is growing at a rate that’s broadly in line with the underwhelming average seen in the opening quarter.” The Nikkei though did follow the US and European rallies yesterday with a 1.8% jump. JGB yields though keep going further negative as the 10 yr yield is now -.12%, down 2 bps on the day. The negative yielding pile of bonds is now at $11.2 Trillion.
Lastly in the region, India’s services PMI fell to 50.2 from 51 and is thus hovering around the flat line. Markit is attributing some of this to “election disruptions” as “Signs that we may see a revival in the service sector in the near term were, however, evidenced by a pick up in hiring activity and improved sentiment.” The Sensex was closed for a holiday.
Shifting to Europe, the Eurozone May services PMI was revised up to 52.9 from 52.5 and that’s up .1 pt from the April print. The services sector in Europe is certainly outperforming the more export dependent manufacturing area. Markit said “Solid growth occurred in spite of a slowdown in the rate of new business expansion to a 3 month low.” Also of note and music to the ECB’s ears, “Demand for staff led to further upward pressure on wages, and this was a key component behind a sharp increase in overall service sector costs.” All of this though was not able to be passed on due to “competitive pressures.” Bottom line, notwithstanding the slight uptick in services, Markit said “growth remains only modest, in part reflecting a spill over from the trade led downturn in the manufacturing sector.” They estimate only a .2% q/o/q GDP gain in Q2. The euro is up a hair but higher for a 4th day vs the dollar. The German 10 yr yield, following the JGB yield, is only getting more negative by 2 bps today to now -.22%. This ahead of the ECB meeting tomorrow.
Italy is the standout European market in the red today with the MIB down by .7%, the 10 yr yield jumping by 8 bps and the Euro STOXX bank index down by 1% driven by Italian banks. The European Commission today officially put Italy on notice for its widening budget deficit and rising debt levels. The letter written to the Italian government said “The absence of prudent budget policies exposes the country to a shock loss of confidence on markets, with a negative impact on the real economy and growth.” The budget battle with Deputy PM Salvini is now heating up as he’s now getting officially called out.