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FED IN A HOLE

On Wednesday, the U.S. Federal Reserve releases the minutes of its most recent meeting, revealing what policy-makers said about the flattening Treasury yield curve and the strength of support for July’s quarter-point rate cut.

But given what has transpired in bond and stock markets since that meeting, the more relevant headlines should spring from the Fed’s annual Jackson Hole Symposium later in the week, with chair Jerome Powell to address the forum on Friday.

Now that the long-awaited inversion of the two-year/10-year yield curve has actually happened, there is some question whether the Fed will lean harder on the easing side to re-steepen the curve and quash recessionary interpretations.

The Fed looks boxed in. Wall Street had a torrid few days last week, as Treasuries sunk to multiyear or even record lows.

Then add in U.S. President Donald Trump’s tweets about “clueless” Mr. Powell and the “crazy” inverted yield curve even as Washington’s trade wars dent business confidence.

Meanwhile, strong July retail sales and gangbuster Walmart earnings indicate the economy’s all-powerful consumer is undaunted. That argues against the Fed doing much more.

Still, futures traders see no chance the Fed will stand pat in September, with CME’s FedWatch tool showing about a 67-per-cent probability of a 25 basis-point cut and 33 per cent odds for a 50-point cut.

By the end of the year, money markets are 78 per cent positive that the target Fed funds range will be 50 to 75 basis points lower than the current 2 per cent to 2.25 per cent (100 basis points equal one percentage point).

PMI PROBLEM

If economists could take any consolation at all from the steadily worsening economic data worldwide, it was that the malaise has appeared confined to manufacturing.

Services, which comprise the bigger part of developed countries’ GDP, has held up pretty well. July numbers though were sobering -- purchasing managers indexes (PMI), generally a good measure of overall economic health, hinted that factories’ sickness may be spreading.

So advance August PMI readings, due on Thursday, will draw scrutiny, especially with global bond markets flagging a looming economic downturn.

Take the United States. Manufacturing there slowed to a near 10-year low in July, to the neutral 50-mark on the PMI index, yet services accelerated to 53, the IHS Markit data showed. But readings from the Institute for Supply Management suggested services were about to take a hit, with new orders hitting three-year lows.

In the euro zone, a dismal manufacturing print of 46.5 contrasted with services at a relatively robust 53.2. But services were down from June, while composite PMIs that combine both sectors slipped to three-month lows of 51.5.

Globally, manufacturing PMIs are deep in the red, with only services holding the composite print above the 50-mark.

If the coming “flash” PMIs confirm that the manufacturing downturn is affecting the services industry, bond markets’ assessment of the economic outlook may be correct.

NO CONFIDENCE

Global bond market developments have of late overshadowed Italian political shenanigans, but that may soon change.

Prime Minister Giuseppe Conte addresses the Senate on Tuesday, after it frustrated Deputy Prime Minister Matteo Salvini’s attempt to pull the plug on his coalition with the Five Star Movement and trigger snap elections.

Meanwhile, Five Star politicians themselves are discussing forming a coalition with the opposition Democratic Party.

The prospect of election uncertainty had sent Italy’s 10-year bond yield premium above Germany to 239 basis points a week back.

It’s retreated since then to around 200 bps. But if President Sergio Mattarella decides there’s no way of creating a stable government, early elections will be called, probably for late October.

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