READY FOR A SCARY EURO ZONE GDP SHOW?
Fears of a major downturn in euro zone powerhouse Germany grew last week following “scary” industrial output figures for June and reports due over the coming week will hold those concerns up to the light.
On Wednesday, quarterly flash gross domestic product data for both Germany and the wider euro zone is released. The consensus forecast from Reuters’ poll is the euro zone GDP grew 0.2 per cent in the second quarter but in Germany – the bloc’s largest economy – it’s expected to have shrunk 0.1 per cent.
Bond markets certainly fear the worst. Ten-year bunds yield a record low of almost -0.60 per cent. The entire German government yield curve out to 30 years is now below zero. Investors are raising red flags about a euro zone recession and a resumption of European Central Bank bond buying as the escalating U.S.-China trade war hit the exporters.
Markets are on high alert for signs Germany and other governments will use such cheap borrowing rates to support the reflation policies of their central banks. A report last week that Germany may issue new debt to finance climate protection caused a brief spike higher in bund yields and the euro.
U.S. ECONOMY READ OUT
After an escalation of the U.S.-China trade row sparked one of the most volatile weeks of the year for U.S. stock and bond markets, investors are focusing on the U.S. economy’s ability to absorb a tariff war with some critical health checks on Thursday.
Already, alarm bells are ringing: U.S. 30-year yields are flirting with record lows, and the premium on three-month Treasury bill rates over 10-year Treasury yields – a closely watched U.S. recession indicator – jumped to its highest since March, 2007. Some analysts now see a more than 50-per-cent chance the longest-ever U.S. economic expansion could slip into a recession within 12 months. PIMCO, one of the world’s biggest bond investors, talked of the possibility of negative Treasury yields.
U.S. July consumer price inflation, due Tuesday, has been tame in recent years and consistently below the Federal Reserve’s 2-per-cent target. Fed chair Jerome Powell said the strong tie between unemployment and inflation was broken 20 years ago and the relationship “has become weaker and weaker and weaker.”
But market watchers are in for deluge of data on Thursday: July retail sales, industrial production, the August Philadelphia Fed index and NAHB housing market indicator are coming. So are weekly jobless numbers and the June TIC data update on the breakdown of Treasury holdings
A quarter-point cut at the Fed’s next meeting on Sept. 18 is now almost fully priced. Markets see one chance in four of a larger 50-basis-point rate cut next month.
SMALL MOVE, BIG DEAL
What seemed like a minor lurch in China’s currency has become a big deal for financial markets. Many fear it may be the beginning of a Chinese competitive devaluation in response to U.S. tariff threats, which in turn could trigger a currency war that may force other regional central banks to slash interest rates. The move also sparked fresh doubts a deal in the U.S.-Sino trade war will ever get done.
The more than 2-per-cent slide in the heavily managed yuan has pushed it to 2008 lows and to the weaker side of 7 per U.S. dollar. Beijing is saying it’s merely letting market forces drive the yuan, not weaponizing the currency, and has done its best through open market operations to contain the move. Chinese trade data showed that, with falling imports and exports, Beijing needs a weaker currency to support its economy.
Yet, the yuan’s drop has set in motion scarier prospects: more geopolitical and business ruptures and threats between the world’s two biggest economies. That is being borne out in plunging stocks and bond yields, tumbling emerging-market currencies and a flight to the safety of dollars, gold, bitcoin and yen.
Markets are watching the back and forth between Washington and Beijing, accusations of currency manipulation, plus the mounting pressure on the Fed to cut rates again. In addition, there is the question of how Beijing will manage expectations around its currency so it doesn’t spark a flight of domestic and foreign capital.
IT’S GETTING FROTHY DOWN THE LONG END
The markets’ rout after an escalation in the U.S.-China trade war marked new milestones for many assets, and government bonds were no exception.
As investors piled into safe-haven assets, Germany’s 30-year bond yield hit a record low, Ireland’s 10-year bond yield turned negative and the Netherlands became the latest to join that growing club of countries with entire yield curves drowning in sub-zero territory.
The evaporation of global yield is pushing investors further out the maturity spectrum. Austria’s 100-year bond is up some 63 per cent year-to-date, with a vertical price chart harking back to similar surges in cryptocurrencies and tech stocks.
Austria’s century bond only highlights a broader trend: the yield on the Bloomberg Barclays Multiverse Index for global bonds with maturities of seven to 10 years hit a record low of 1.44 per cent this week.
Going “long” U.S. Treasuries has featured as what fund managers think is the “most-crowded trade” for two months straight in a Merrill Lynch survey. That could prove a bad omen – assets named “most crowded” usually sink soon afterward. Time for a bubble to pop?