The Week Ahead: Wonky finance-speak

A relatively light event calendar can be deceptive, especially in these Summer months, when many market participants and traders are sunning themselves on the beach (or watching cricket). However, don’t be fooled as ongoing trade tensions and global growth worries are ever-present and have sparked some volatile moves in markets.

Treasuries had their biggest monthly rally in more than four years last week as bond markets have sounded a recession warning, with ratings agency S&P warning investors it is on ‘high alert’ for the US economy.

We’ve seen yield curve inversion make the lexicon of Joe Public, another esoteric finance term to be added to those others made famous in recent history – see quantitative easing, CDOs etc etc. This red flag in the bond market ordinarily sends a powerful signal about the health of the economy and its warning of an economic downturn. In fact, the omen has presaged every US recession since the second world war.

However, it tells us little about when a recession will occur. For example, the last inversion took place at the end of 2005, but the recession didn’t officially start until 24 months later. We also think it is worth considering one of the main reasons for this move. If you were to adjust the yield curve for central bank asset purchases, which total over $11 trillion, then it would likely not be that flat at all!

Even though bond markets are signalling recession risks ahead, economic data in the US especially, is more consistent with a slowdown than an outright prolonged downturn. Consumption, which accounts for roughly 70% of GDP is currently underpinned by the lowest unemployment rate in nearly fifty years. Benign inflation and stable wage growth are also supporting consumer spending, as evidenced by the solid US retail sales figures last week.

We have an interesting week ahead of us, as we get more colour on the US macro outlook with the release of manufacturing PMI which is expected to fall below the 50 threshold in line with the global weakness in manufacturing. 

Wednesday’s FOMC Minutes may appear rather stale, and hawkish as a lot has happened since the Fed’s ‘mid-cycle adjustment’. Chair Powell’s press conference suggested this would not be the start of an easing cycle but less than twenty-four hours later, Trump made his announcement that he would apply a 10% tariff on $300 billion of Chinese imports. Markets are currently pricing in roughly four more cuts in addition to the one already delivered with investors placing odds of 21% on a half-point cut in September.

In Europe, the ECB will publish an account of its July policy meeting on Thursday after changing its rates guidance to suggest that rates could be cut soon. A power struggle is occurring in Italy’s government and the drama will continue with an expected vote of no confidence in Prime Minister Conte. 

The main draw of the week will be the Federal Reserve’s annual symposium at Jackson Hole, taking place from August 22-24. Numerous central bankers will be attending, including Powell who is scheduled to speak on Friday, when we will get an update from him on how he sees this ‘mid-cycle’ and whether the Fed may move more swiftly and aggressively owing to the recent increase in trade tensions.