Volume 23, Issue 7 February 11, 2019.

  Source: Globe & Mail


Global Trade is Falling Down, Falling Down
Douglas Porter, CFA
BMO Chief Economist

Following a crackling six-week surge, global equities took a step back this week on a wave of soft economic data—especially from Europe—and renewed concerns over prospects for the U.S./China trade talks. After brushing up against the 200-day moving average earlier this week, the S&P 500 dipped through the back-half amid trade jitters. In tandem, longer-term Treasury yields revisited levels not seen since the opening days of the year (the 30-year fell below 3%). While the rally in North American bonds has been impressive, it can’t hold a candle to the move in German bunds, where the 10-year yield has careened down to just 8 bps (yes, 0.08%) from a peak of 77 bps almost exactly a year ago. Completing the risk-off move this
week, the U.S. dollar took a small step forward and oil prices sagged somewhat.

The main driver for this week’s moderate market angst was not the State of the Union, it was the State of the Global Economy. A suddenly much more subdued tone around the negotiations with China—which resume in Beijing on February 14, at a “high level”—rattled the cozy consensus that a half-loaf deal could be reached by the March 1 deadline. It turns out that the Presidents are not going to meet before then, suggesting that an extension of talks may be the best possible outcome at this
point.

Suffice it to say that we have long been sceptics on a successful conclusion on the U.S./China file. Consider, for example, the painful NAFTA negotiations: In that case, we had a perfectly good agreement to begin with, a moderate bilateral imbalance (between the U.S. and Mexico), and generally positive relationships between the three, and it took more than a year of hard bargaining. In this case, we have no current deal, a massive bilateral imbalance, the U.S. aiming for structural changes, and two adversaries at the table. Simply, there is no way that a full-meal deal can be reached in a short period of time. Whatever unfolds in the next three weeks, one would suspect that this issue will hover over the market for many, many months to come.

As a brief sidebar on NAFTA/USMCA, note that even this—seemingly uncontroversial—deal is going to face tough sledding in Congress (see Michael’s Thought below for some of the procedural details). A piece this week in the New York Times indicated that the USMCA faces serious resistance on both sides of the aisle, and of course it arrives at a time of a Grand Canyon-style political divide. The fact that a number of Republican Senators are warning the President not to terminate NAFTA (in order to force the House’s hand on USMCA) is cold comfort; it’s a positive that they are prodding him, it’s a negative that they feel the need to do so. From Canada’s perspective (and Mexico’s), the prospect of many more months of uncertainty on the trade file is about as welcome as endless replays of the Super Bowl half-time show. But at least the two NAFTA partners may be spared some of the worst possible protectionist measures, since they won’t be responsible for any delays in the new pact.

On top of ongoing concerns about the outlook for trade, we saw a wave of weak trade and production data looking backwards this week. Recall that it was only in late September that the U.S. imposed the latest round of big tariffs on China (10% on
$200 billion of imports), and the global data may now only be catching up with the resulting chill in activity. Germany, in particular, has been harshly sideswiped by the cooldown in trade, and in China’s economy specifically. As one wag put it, “another day, another piece of terrible German data”. The stand-out was a fourth consecutive monthly drop in industrial production in December, leaving it down a hefty 3.9% y/y.  That’s weaker than in the depths of the Euro crisis, and cannot be explained away by any special factor as many sectors are flagging. This coming week will bring Q4 GDP results for Germany and the EU.

To highlight just some of the sickly figures pointing to a notable slowdown in global trade:

 The Baltic Dry Index fell to its lowest level in almost three years this week and is
now down 44% y/y.
 U.S. imports tumbled 2.9% in the (delayed) November trade figures.
 A measure of global trade volumes (from CPB) sagged 1.3% in the three months
to November, its biggest slide since mid-2015.

In this environment, there was a wave of downgrades to the 2019 growth outlook in the industrial world, which, in some cases, took an end run around our already subdued forecasts. Most notably, the EU carved its call for GDP this year to 1.3%
(from 1.9% as recently as November), while the BoE cut the U.K. call to 1.2% (from 1.7%, also in November). Even the lucky country got into the act, with the RBA slicing its GDP outlook half a point (albeit to a still solid 2.75%—this is, after all, the
country that hasn’t had a recession since pre-internet days, or around the time the wheel was discovered). While none of the revised forecasts are especially controversial or surprising, the synchronicity of the sudden downgrades is telling, and simply reinforces the point that we are in a very long pause for interest rate hikes globally.

 

Have a great week.

Frank & Mark




Source: Globe & Mail, BMO Capital Markets, Bank of Canada

Canada:
Canada’s S&P/TSX Composite Index notched its sixth weekly gain in a row, even as most other major markets struggled against increasing economic and political uncertainty. The benchmark index touched its highest level in almost four months, lifted by corporate earnings reports, and the dovish tone set by the U.S. Federal Reserve (the Fed) the other week.  With interest rate policy at the Bank of Canada (BoC) believed to be in “wait and see” mode, as it is at the Fed, bond yields in both countries drifted lower this week. As a result, sectors that are interest-rate sensitive and defensive, like real estate, staples, and utilities, led the TSX advance. The technology sector also made gains, while energy and health care stocks lagged.  Year-to-date, the TSX is up 9.1% and the benchmark 10-year yield was slightly lower ending the week to yield 1.88%.


U.S.:
The S&P 500 saw strengths and weaknesses among sectors similar to those in the TSX. Energy and materials led the decliners, while the utilities and real estate were among the stronger groups. The technology and industrials sectors were also positive. These sectors were among the hardest hit in December’s sell off, and so continue to rebound sharply with news of generally better-than-expected earnings reports. Uncertain trade negotiations were evident in the market at the end of the week. Year-to-date, the S&P 500 is up 8.0%, the Dow Jones Industrials are up 7.6%, and the Nasdaq is up 9.9%.  The yield on the 10 year Treasury closed at 2.63%.



Source: BMO Capital Markets