Economic Outlook – 9 December 2018


  • The front-end of the yield curve inverted last week, with two- and three-year Treasury yields rising above the five-year yield.Given that many analysts view an inversion as an omen for an economic downturn, the inversion brought heightened sensitivity among markets to the increased probability of a recession on the horizon. It is to be noted, however, that while the yield curve has inverted prior to each recession since 1970, it has done so at varying degrees of lead time (from 8 to 23 months). Also, the spread between the 2-year and 10-year Treasury yields, a more widely recognised spread, has flattened recently, but has not yet inverted.
  • Markets spent much of the week pricing out multiple US FederalReserve rate hikes in 2019, and Friday’s softer-than-expected jobs report bolstered the case for a less aggressive Fed next year. A hike is still expected at the 18 and 19 December meeting of the Federal Open MarketCommittee, though the quarterly pace of hikes the market has become accustomed to could be altered, with the Fed taking a more wait and see approach as US economic data becomes more mixed, global growth slows and a plunge in oil prices reduces already modest inflation pressures.
  • Total US nonfarm payroll employment increased by 155,000 in November, somewhat less than the consensus expectation of 198,000. The weak print was further amplified by a total net revision of -12,000 for the previous two months. However, the underlying pace of employment growth at close to 200,000 per month is stronger than usually expected at this late stage in the economic cycle, and there is nothing to suggest any significant deceleration in US employment growth at the moment. The unemployment rate was unchanged at a 49-year low of 3.7% last month, well below Fed officials’ current 4.5% estimate of the long-run natural rate of unemployment.
  • Fresh data from the Institute for Supply Management (ISM) last week pointed to robust activity in both the manufacturing and nonmanufacturing sectors in November. The manufacturing prices paid component fell sharply, while the non-manufacturing measure continued to trend higher. The anecdotal evidence from respondents of both surveys nonetheless suggests that tariffs are having a wide-ranging impact across industries, such as higher input costs weighing on producers.
  • US stocks dropped sharply, with the technology-heavy Nasdaq Composite Index and the smaller-cap benchmarks faring worst. Markets were again highly volatile, although the Cboe Volatility Index (VIX) remained below the multi-month highs it established in October. Tumbling longer-term Treasury bond yields heavily influenced equity markets, weighing on sentiment generally and punishing financial shares by lowering lending margins for banks but benefiting utilities stocks, whose dividends became more attractive in comparison.
  • US treasury prices rose as yields fell, and US municipal bonds produced good returns for the week as muni yields followed Treasury yields lower. However, munis slightly underperformed Treasuries going into Friday. Despite worries about increased supply, demand for munis across the yield curve was more than adequate to digest the new issuance. The investment-grade corporate bond market started the week with a firmer tone and riskier names outperformed. However, the positive sentiment was short-lived as equities turned lower. Most market segments declined as the week progressed, and the automotive industry was a notable underperformer. Market liquidity was a growing concern, with relatively few trading days left in the year, and issuance was significantly lower than expected.


  • UK manufacturing PMI strengthened slightly in November to 53.1 from 51.1 in October. The consensus expectation was 51.7. According to the survey, output growth improved, as did overall new orders, but export orders continued to decline. Future output expectations also fell further and companies cited ongoing global trade tensions, reduced client interest from overseas as well as Brexit uncertainty. The overall degree of optimism dipped to a 27-month low, according to the survey. According to a newly released survey from the manufacturers’ trade body, EEF, UK manufacturers are currently making as many goods as possible and piling them up in storage in response to fears of raw materials drying up in the event of a no-deal Brexit. According to EEF, precautionary stockpiling has allowed firms to maintain higher production levels, despite a pronounced drop in export orders. The PMI survey also confirmed that some of the increase in domestic new orders and production was related to stock-building.
  • The British Parliament will vote on the United Kingdom’s withdrawal agreement with the European Union on Tuesday with Prime Minister Theresa May in a severely weakened political state. May faces pressure from both the Remain and Leave camps, with remainers hoping to force a softer Brexit that will keep the United Kingdom closely aligned with the EU on trade while leavers fear the current deal does not go far enough to distance the UK from the EU. At present, it looks as though the agreement will not be ratified, putting May’s leadership in grave danger. What will happen next is unclear. May could face a leadership challenge, she could resign, a general election could be called or there could even be a second Brexit referendum. Time is running short, however, with the UK scheduled to quit the EU on 29 March.
  • The British public’s expectations for inflation in a year’s time have risen to a five-year high but fewer people expect an interest rate hike over the next 12 months, a Bank of England survey showed on Friday. The BoE said median expectations for inflation in a year’s time rose to 3.2% from 3.0% in August’s survey.
  • British house prices rose at their slowest pace in six years in the three months to November, mortgage lender Halifax said on Friday, the latest sign of weakness in the housing market as Brexit approaches. Annual house price growth slowed sharply to 0.3% from 1.5% in the three months to October, Halifax said. Halifax’s house price index was rising by nearly 10.0% a year at the time of the 2016 Brexit vote.


  • France’s CAC 40 Index also fell. President Emmanuel Macron’s government cancelled a planned fuel tax increase for 2019, as it sought to calm a nationwide protest movement, known as the “gilets jaunes,” or yellow vests. The movement, now in its third week, started as a motorists’ campaign against the rising cost of fuel and has become the biggest political crisis of Macron’s 18-month presidency and caused the worst riots in Paris in 50 years. The government initially said that the hikes would be suspended for the first half of 2019, but late Wednesday, they were cancelled outright. The protesters have said they will keep up their fight because other demands over the cost of living have not been met. Protesters are calling for a return of the French wealth tax and the freeze of electricity prices.
  • Germany’s DAX index, the broadest measure of shares in Europe’s largest economy, fell more than 4.0% for the week, slipping into bear market territory, and in line with steep declines in global stocks. The index, which has lost 20.0% since its January 23 peak (its worst performance since 2008) is very sensitive to global economic concerns given the many automotive-heavy and export-driven member companies. Automakers and industrial stocks led the declines on concern that a re-escalation of US and China trade tensions could put barriers on exports to Germany’s two biggest markets.
  • European stocks fell throughout the week, as hopes soured for reduced trade tensions between the US and China. The pan-European STOXX Europe 600 Index and the FTSE 100 Index fell more than 3.0% on Thursday, their worst one-day declines since the June 2016 Brexit vote. The STOXX 600 Automobiles & Parts subindex was hit particularly hard, as the US affirmed that it does not have a deal in place for China to eliminate tariffs on American-made cars.


  • Markets in mainland China ended the week higher, but the arrest of a Chinese telecom executive jeopardized the trade truce struck by the US and China at the Group of 20 summit in Argentina last weekend. The Shanghai Composite Index and large-cap CSI 300 Index began the week on a strong note after US President Trump and his Chinese counterpart Xi Jinping met at the summit and agreed on a 90-day tariff truce to allow more time for talks. The temporary truce lifted hopes that the US and China would resolve a months-long trade rift that has increasingly been taking a toll on profitability for US and Chinese companies.
  • The same day, however, Canadian authorities detained Sabrina Meng Wanzhou, the chief financial officer of Chinese network gear maker Huawei Technologies, at the US’s request for violating sanctions on Iran. The arrest of Meng, who faces extradition to the US, drew outrage in China and threatened to sink Sino-US relations to a new low. Both the Shanghai Composite and the CSI 300 Indexes pared their gains by the end of the week. The Shanghai Composite Index posted a weekly gain of 0.7%, while the large-cap CSI 300 Index added 0.3%. In addition to her post at the world’s biggest wireless equipment supplier, Meng is the daughter of Huawei founder Ren Zhengfei, a former People’s Liberation Army officer who became one of China’s best-known entrepreneurs. Though Meng’s arrest was widely seen as a shocking event, Huawei has been under US scrutiny for national security concerns for the past several years. In April, The Wall Street Journal reported that the US Justice Department was probing the company over whether it was trying to evade sanctions against Iran.
  • While the United States and China agreed at the G20 summit to embark on an intensive 90-day negotiation toward coming to a long-term agreement on trade, the talks have gotten off to a rocky start. US president Donald Trump issued a series of tweets which suggest that the US will hold a hard line in the negotiations, indicating that there will be a “real deal” or “no deal at all” and noting that he is a firm believer in tariffs. A day after markets tumbled in the wake of the tough talk on trade, the president said China is sending strong messages about wanting to conclude a deal. The Chinese Ministry of Commerce, for its part, said that Beijing is “very confident” about reaching an agreement within the 90-day negotiating window.
  • The CNY weakened markedly versus the USD over the summer, and has slowly depreciated further during the autumn as trade-war fears and slowing growth have kept depreciating pressure on the CNY. As the USD/CNY neared 7.0, the authorities seemed to gear up interventions somewhat to defend this level. Meanwhile, the effective trade-weighted exchange rate has been more stable amid general USD strength. Following the meeting between China’s Xi and US President Trump in early December, the USD/CNY fell again amid hopes of a breakthrough in trade war-related negotiations.

Sources: Wells Fargo, T. Rowe Price, Reuters, MFSInvestment Management, Handelsbanken Capital Market.