Fed Rate Bets Vanish as Global Factory Growth Slows, Bond Yields Slide
New York (Jan 2) U.S. Treasury bond yields tumbled Wednesday, taking benchmark 10-year borrowing costs to the lowest levels in more than 11 months, as a slowdown in global manufacturing activity, alongside the prospect of an extended U.S. government shutdown, triggers safe-haven flows in markets all over the word.
Benchmark 10-year U.S Treasury note yields fell to an 11-month low of 2.652% in early European trading, while German bund yields, a proxy for risk-free rates in Europe, slipped below 0.165% for the first time since September 2016. U.S. 2-year notes were marked at 2.496%. The moves followed weaker-than-expected readings of manufacturing activity in Europe last month, and the first contraction in China for nearly two years, as the ongoing trade war between Washington and Beijing clips growth prospects in the world's biggest economies.
"We believe that the data reflect that not only has the trade war damaged growth in the export sector. It has also hurt export-related supply chain companies and in turn, domestic demand," said ING's China economist Iris Pang. "If domestic demand is not supported by fiscal stimulus quickly, then further weakening will pose a risk to job security. That could create a vicious downwards cycle."
Europe's key manufacturing sector also closed out 2018 on a weak note, with the IHS Markit assessment sliding to the lowest level since February 2016 and activity in Germany slipping to a 33-month low.
"The last three months of 2018 saw manufacturers report the worst quarterly performance in terms of production since the second quarter of 2013," said IHS Markit's Chris Williamson. "Worryingly, current production levels were achieved only by firms eating into backlogs of orders received in prior months and a dearth of new orders means capacity will be cut back in coming months unless demand revives. December saw a third consecutive monthly drop in new orders."
The downbeat assessments also appears to have cemented investor views on near-term rate hikes from the U.S. Federal Reserve, which have faded significantly since Chairman Jerome Powell and his FOMC colleagues raised the Fed Funds level for the fourth time last year in December -- to a range of 2.25% to 2.5% -- and said "gradual" moves higher would follow in 2019.
The CME Group's FedWatch tool, however, which assigns rate hike probabilities based on futures prices, suggests the highest chance of a 2019 rate hike falls in September. But even then, investors are only assuming a 14.2% chance of a move higher from Powell and his colleagues.
However, with U.S. unemployment sitting at the lowest level since 1969, and the Atlanta Fed's GDPNow forecasting tool suggesting a 2.7% fourth quarter growth rate, Fed officials could continue to push for higher rates in order to ensure that wage pressures don't result in faster inflation, particularly given the fact that lower domestic gas prices will prime the consumer spending pump in the months ahead.
U.S. stocks has reacted in kind, with the S&P 500 closing out its worst year since the global financial crisis this week with a 13.9% fourth quarter decline that was fueled, in part, by dismay over the Fed's decision to signal 2019 rate hikes in the face of weakening consumer sentiment and ongoing trade war concerns.
"We're assuming here that the reaction to the fourth quarter rollover in stocks won't be so severe that it triggers a slowdown in growth big enough to start pushing up the unemployment rate," wrote Pantheon Economics Ian Shepherdson. "If that happens, the Fed won't tighten again, though they likely won't start easing quickly, either."
"Consumers' confidence probably will drop over the next couple of months, though the hit from the stock market will be partly offset by the impact of lower gas prices, which are the other key driver of sentiment in the short-term," he added.
Powell is due to speak Friday, alongside former Fed Chairs Janet Yellen and Ben Bernanke at the American Economic Association and Allied Science Association Meeting in Atlanta, but his remarks may not be as specific as markets would like owing to the fact that the ongoing government shutdown will delay the release of key economic data, particularly in the housing sector, for the month of December.
That said, the Labor Department will publish December non-farm payroll data as usual at 8:30 am Friday, with analysts expecting to hear that U.S. employers added 180,000 new jobs last month, holding the headline unemployment rate at 3.7% and average hourly wage growth at 3%.
TheStreet
