Take Five: Tweet, Freak, Sleep, Repeat

June 1, 2019


The G20’s finance ministers and top central bankers brass will meet in Japan next weekend, and with the global trade war escalating rapidly again — Mexico has been dragged back into the thick of it — they’ll have plenty to talk about.

Spooked markets will hope blockbuster tete-a-tetes among U.S. President Donald Trump, President Xi Jinping, Russian President Vladimir Putin and Mexican leaders all make progress.

But the host’s top currency diplomat, Masatsugu Asakawa, has already tried to manage expectations, saying the post-meeting communique won’t include language saying members will fight protectionism, and the Bank of Japan governor has been sounding cautious.

That’s one reasons why the outlook for the global economy is now looking so grim. Bond markets are convinced a global recession is coming, Australia could become the second advanced economy to start cutting interest rates again next week — to a record low of 1.25% — and some economists are now penciling in as many as five Fed cuts.

Global PMI activity and trade: https://tmsnrt.rs/2WzqeyD


With Trump lobbing a new grenade — possible tariffs on Mexico — into the trade battle, the world may have stepped closer toward recession. Bond markets shout that warning loudly: three-month U.S. yields are well above 10-year rates, the so-called curve inversion that’s foretold most 20th century U.S. recessions.

But could it be that bond markets are behaving like Chicken Little, warning the sky is falling? After all, years of money-printing may have weakened bonds’ predictive power. So let’s look at other gauges of a downturn?. First, unemployment. It rose before the past two recessions, but U.S. unemployment is now near 50-year lows. Equities? May will be the first month in the red this year for global and U.S. stocks. But before the last two recessions, U.S shares turned down on a 12-month rolling basis — that hasn’t happened yet this time. Looming recessions push up junk bond yields, but they’ve actually fallen in 2019. On the downside, Korean exports, a bellwether of global growth, have fallen for five straight months. The Baltic Dry Freight index, a leading indicator for raw-material demand, is also down this year.

So signals are mixed. Fed Vice Chair Richard Clarida has just signaled interest rates might be cut if growth looks at risk. But his view overall was that the U.S. economy was in a “very good place”.

U.S. Yield Curve: http://tmsnrt.rs/2zUqXiW


It’s time for action again at the European Central Bank. It will use its June 6 meeting to disclose the details for another round of ultra-cheap, multi-year TLTRO loans. Corporate lending in April expanded at its best rate this year, a positive sign. But with the growth outlook weak (think trade wars, Brexit, weak PMIs), generous TLTRO terms would be a sure-fire way to help.

But how generous is generous? There could be disappointment if they are not as low as previous rounds, especially with the German Bund yields, which anchor euro zone borrowing costs, at record lows.

Evaporating inflation expectations, a U.S.-China trade war that could soon spill into Europe and worries about Italy all mean ECB chief Mario Draghi should stick to his trademark dovish tone. The bank will also have new economic forecasts to chew over.

Time to TLTRO, pt. III: https://tmsnrt.rs/2WBhIPI


The U.S. Federal Reserve holds a two-day conference in Chicago, where central bank insiders will huddle with private-sector economists to debate how the Fed might tweak things to better meet its dual mandate of stable inflation and full employment.

Fed brains have been flummoxed by the apparent breakdown in the relationship between employment and prices and by their inability to coax inflation up to their 2% target for any length of time. Since establishing that target in 2011, the Fed has managed to meet it only a handful of times, and with the trade war ratcheting up it is again drifting out of reach.

When unemployment was last this low, half a century ago, both headline inflation and core inflation, stripping out food and energy costs, were far higher than they are today. It’s far from certain what will emerge from Chair Jerome Powell’s framework review initiative, but it is clear that Fed officials are fretful of losing the confidence of consumers and markets in their ability to steer inflation.

Low inflation: The Fed’s albatross – https://tmsnrt.rs/2Kf6qdx

5/MAN OF ACTION? “There are those who talk and those who act,” Italian Deputy Prime Minister Matteo Salvini has been quoted as saying. During his one year in office, Salvini has certainly shown he can talk. Now markets may be find out if he’s also a man of action.

Emboldened by European parliamentary elections, in which his far-right party got a third of the votes, Salvini is threatening to tear up EU fiscal rules. He argues the result gives his party a mandate to push through tax cuts and fight EU budget rules. Doing that would end the budget truce with the European Commission after less than six months.

The Rome-Brussels standoff will escalate after June 5 if the Commission decides to start disciplinary steps against Italy for failing to rein in debt. It could impose fines as high as 8.7 billion euros.

We may also learn soon if Salvini intends to dissolve his coalition with the 5-Star Movement and call snap elections, something he has so far ruled out.

All that has put markets on high alert. Shares in Italian banks have fallen to their lowest since September 2016. Italian bonds sold off after the election and yield spreads over German yields have widened, approaching last November’s 300 bps.

The risk is that worsening debt metrics trigger credit rating downgrades in coming months. That would raise bond yields further, hurting Italian banks. If Salvini — and the Commission — do act, buckle up for more turbulence.

Italian assets: Man of action? – https://tmsnrt.rs/2KoAofh

(Reporting by Sujata Rao, Dhara Ranasinghe and Marc Jones in London, Danilo Masoni in Milan, Marius Zaharia in Hong Kong, Vidya Ranganathan in Singapore and Dan Burns in New York; editing by Larry King)

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