Investors’ risk appetite was curbed slightly following weak economic data (euro area PMIs) and pockets of US political stress
According to consensus estimates, as well GDPNowcast models from regional Federal Reserve Banks, the US economy is expected to revert to its potential growth rate of circa 2% yoy in H2:2019 from 2.5% yoy in H1:2019 and 2.9% yoy in 2018 (see Economics).
On the one hand, the support from 2018 fiscal policy through higher government spending and reduced corporate and household taxes is expected to fade gradually. According to the Brookings Institute, the contribution of fiscal policy to quarterly annualized real GDP growth will be slightly negative from H2:2020 onwards. On the other hand, the prolongation and/or escalation of risk factors such as “trade wars”, Brexit, geopolitical risks and political tensions may alter the gradual easing of the US growth momentum into recession. Indeed, US interest rate markets price in recession-like conditions, with the yield term-spread between 10-Year Treasury notes (-100 bps YtD to 1.68%) and 3 month bills (-57 bps YtD to 1.79%) in negative territory since May 2019.
Consumer spending has been strong during this orderly slowing of headline growth, albeit posting below-than-expected gains in August (see Economics). Instead, business investment has decelerated significantly. Surveys from six regional Federal Reserve Banks regarding corporate capital expenditure plans suggest that the subdued momentum for US business investment will likely remain in place throughout the rest of the year. Our equally-weighted index of business intentions six-months forward has declined to 16 from a peak of 36 in February 2018 (see graph). The ISM manufacturing index also fell further to 47.8 on Tuesday October 1st (lowest since June 2009). The prospects for business investment remain closely linked to how US-China tensions evolve.
Increased tariffs add to uncertainty. Moreover, the latest press reports that the US is considering ways to limit US-based investors’ portfolio flows into China (including delisting Chinese companies from US exchanges and limiting US government pension fund exposure to China) do little to alleviate the situation. On a positive note, US-China trade talks are expected to take place on October 10th/11th.
Equity markets, which appear to price in better macroeconomic results relative to interest rates, took a modest hit on Friday. The tech-heavy Nasdaq was down by 2.2% wow (20% YtD) as the US-shares of Alibaba and Baidu ended the session deep in the red following US de-listing threats, while the S&P500 declined by 1% wow (+18% YtD). US non-investment grade corporate bond spreads widened by c. 10 bps to 399 bps (-134 bps YtD). Risk-appetite improved on Monday (SPX: +0.5%) as P. Navarro claimed that the reports regarding de-listing were “inaccurate”.
Finally, US domestic political developments took a turn for the worse, as Democrats appear ready to carry out an investigation into allegations that Trump inappropriately pressured his Ukrainian counterpart to investigate former VP Biden and his son, in exchange for military aid worth $400mn. While impeachment by the House is probable (a simple majority of 218 votes is needed with Democrats holding 235 seats), conviction in the Senate requires a majority of ⅔, with Republicans holding 53 seats out of 100. At the same time, both foreign (trade deals) and domestic (infrastructure, payroll tax cuts) issues could be delayed, adding to weaker economic momentum.