Compromised

The punditry seemed quite surprised
That trade talks have been compromised
If President’s Xi
And Trump can’t agree
To meet, forecasts need be revised

What then, ought the future might hold?
It’s likely that stocks will be sold
And Treasuries bought
As safety is sought
Plus rallies in dollars and gold

Risk appetites have definitely diminished this morning as evidenced by yesterday’s US equity decline alongside a very weak showing in Asia overnight. The proximate cause is the news that President’s Trump and Xi are not likely to meet ahead of the March 1 deadline regarding increased tariffs on Chinese goods. And while trade talks are ongoing, with Mnuchin and Lighthizer heading to Beijing next week, it seems pretty clear that the market was counting on a breakthrough between the presidents in a face-to-face meeting. However, not unlike the intractable Irish border situation in the Brexit discussions, the question of state subsidies and IP theft forced technology transfer are fundamental to the Chinese economy and therefore essentially intractable for Xi. I have consistently maintained that the market was far too sanguine about a positive outcome in the near-term for these talks, and yesterday’s news seems to support that view.

Of course, eventually a deal will be found, it is just not clear to me how long it will take and how much pain both sides can stand. Whether or not Fed Chair Powell believes he capitulated to Trump regarding interest rates, it is clear Trump sees it in that light. Similarly, it appears the president believes he has the upper hand in this negotiation as well and expects Xi to blink. That could make for a much rockier path forward for financial markets desperate to see some stability in global politics.

The trade news was clearly the key catalyst driving equities lower, but we continue to see weakening data as well, which calls into question just how strong global growth is going to be during 2019. The latest data points of concern are Italian IP (-0.8%, exp +0.4%) and the German trade surplus falling to €13.9B from €20.4B in November. Remember, Germany is the most export intensive nation in the EU, reliant on running a significant trade surplus as part of its macroeconomic policy structure. If that starts to shrink, it bodes ill for the future of the German economy, and by extension for the Eurozone as a whole. While it cannot be too surprising that the Italian data continues to weaken, it simply highlights that the recession there is not likely to end soon. In fact, it appears likely that the entire Eurozone will be mired in a recession before long. Despite the ongoing flow of weak data, the euro, this morning, is little changed. After a steady 1.25% decline during the past week, it appears to have found a little stability this morning and is unchanged on the day.

In fact, lack of movement is the defining feature of the currency markets this morning as the pound, yen, Loonie, kiwi, yuan, rupee and Mexican peso are all trading within a few bps of yesterday’s levels. The only currency to have moved at all has been Aussie, which has fallen 0.25% on continued concerns over the growth prospects both at home and in China, as well as the ongoing softness in many commodity prices.

The other noteworthy items from yesterday were comments from St Louis Fed president Bullard that he thought rates ought to remain on hold for the foreseeable future. Granted, he has been one of the two most dovish Fed members (Kashkari being the other) for a long time, but he was clearly gratified that the rest of the committee appears to have come around to his point of view. And finally, the Initial Claims data printed at a higher than expected 234K. While in the broad scheme of things, that is still a low number, it is higher than the recent four-week average, and when looking at a chart of claims, it looks more and more like the bottom for this number is likely behind us.

A great deal has been written recently about the reliability of the change in the Unemployment rate as a signal for a pending recession. History shows that once the Unemployment rate rises 0.4% from its trough, a recession has followed more than 80% of the time. Thus far, that rate has risen 0.3% from its nadir, and if claims data continues to rise, which given recent numbers seems quite possible, the implication is a recession is in our future. The one thing we know about recessions is that the Fed has never been able to forecast their onset. Given the fact that this recovery is quite long in the tooth, at 115 months of age, it cannot be surprising that a recession is on the horizon. My concern is that the horizon is beneath our feet, not in the distance.

There is no US data to be released today although next week brings both inflation and manufacturing data. But for now, all eyes are on the deteriorating view of the trade situation, which is likely to keep pressure on equity markets (futures are currently pointing lower by 0.5%) while helping support the dollar as risk is continuously reduced.

Good luck and good weekend
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