This evening there’ll be a debate
And markets are willing to wait
To see if the polls
Will change who controls
The future, and all of our fate
 
Until then, it seems pretty clear
Investors are waiting to hear
Amid all the lies
If taxes will rise
And whether our future’s austere

 

It seems that all eyes have begun to focus on this evening’s debate between former President Trump and Vice-president Harris, with both sides bombarding every source of information available to the average person with their own spin.  Within the market context, the debate is about which candidate’s policies will be better for the economy and by extension equity markets.  As I am just a poet, this is all far above my pay grade.  Trying to be somewhat objective (and I’m sure you have figured out I lean toward the traditional conservative view of less government is better), from what I have read, neither side paints a particularly enticing picture.  

Tariffs have never proven effective, but the concept of taxing unrealized capital gains is abhorrent, and if enacted would be extremely detrimental to the nation.  Ultimately, I think the phrase, energy is the economy, is one to keep in mind as understanding that idea leads to an understanding of how policy choices will impact economic activity over time.  One need only look at Germany’s economic suicide following their Energiewende policy that has raised the price of electricity dramatically (it is 3x US prices) and led to a slow-motion collapse of the nation’s once strong manufacturing sector, to get a glimpse of the future without cheap and abundant energy.

So, with the Fed in their quiet period, let’s turn our attention overseas for any other news of note.  Chinese trade data was released overnight and showed a further increase in their trade surplus ($91B), news which probably did not brighten President Xi’s day as imports remain incredibly weak, a strong signal that the domestic economy is still stumbling along poorly under the weight of the ongoing collapse in the property bubble there.  The problem was highlighted by Exports growing 8.7% while Imports grew just 0.5%.  Chinese markets were largely unimpressed with this as the CSI 300 rose just 0.1% (although that is better than many of its recent sessions) and the renminbi slipped 0.1% despite a broader trend of modest dollar weakness.

The other notable data was from the UK where the employment situation continues to improve, with the Unemployment Rate falling to 4.1% while wages keep growing at 5.1% and there was a significant uptick in Employment by 265K with all of that data at least as good as expectations with some exceeding them.  When combining the resilience of the employment situation with the fact that inflation remains well above target in the UK, it continues to be difficult to understand the near desperation that the BOE has to cut interest rates.

In fact, that last comment can be applied to the US as well.  A look at the data shows that the job market, while not as robust as it had been last year, remains pretty solid, at least according to the BLS and the recent NFP report, while inflation, no matter how it is measured, remains well above the Fed’s 2.0% target.  In fact, the Atlanta Fed’s GDPNow data moved higher after the NFP report and is now sitting at 2.5% for the current quarter, which would follow the 3.0% Q2 measure.  Again, other than Powell’s promise to cut rates at Jackson Hole, it is not clear the data is pointing to that, at least not the data on the surface.  In fact, Torsten Slok, a well-known economist at Apollo Group, has put out a very interesting compilation of very current data showing that the economy seems to be doing fine.  My point is from the Fed’s perspective, this incredible desire to cut rates seems odd.

But that is the reality, central banks everywhere really want to cut rates, and come Thursday, the ECB will be the next to do so.  The question of 25bps or 50bps for the Fed next week seems almost moot compared to the fact that the market is pricing in 250bps of cuts by the end of next year.  Here’s the problem with that pricing; if the Fed does stick the soft landing, that seems like far too much policy ease without driving a significant uptick in inflation screwing up the soft landing theme.  However, if the economy does fall into recession, they will cut a lot more than that, probably on the order of 350bps to 400bps (Fed funds falling to 1.50% – 2.00%).  And one more thing to remember, QT continues in the background as the Fed gradually reduces the size of its balance sheet.  But can they continue to remove that liquidity while cutting rates as much as the market anticipates?  That feels like a very tough task and in truth, if the Fed is cutting rates, I think we are more likely to see QT turn into QE than anything else.  

So, regardless of the lack of activity today, there is much still to come.  As to today, let’s survey the rest of the markets outside China.  After yesterday’s solid rallies across US equity indices, other than Japan (-0.2%) and Korea (-0.5%), the rest of Asia had solid performances with gains ranging between 0.2% (HK) and 0.75% (Indonesia).  Europe, too, is mixed this morning with some modest gains (CAC, IBEX) and some modest declines (DAX, FTSE 100) with the latter more surprising given the solid employment data.  Perhaps that is the market showing concern the BOE will not cut rates as much as previously expected.  As to US futures, they are little changed at this hour (7:50).

In the bond market, Treasury yields are higher by 1bp this morning and we have seen similar rises across the entire European sovereign market.  Of more interest is the fact that the US 2yr-10yr yield curve is now positively sloped by 3bps this morning, with the long inversion finally having ended.  At least at those maturities.  But if you look at the 3mo (4.98%) – 2yr (3.68%) spread of -130bps, that is dramatically inverted with the market pricing in a huge amount of Fed rate cuts coming ahead.  I cannot help but look at that and be confused about equity analysts’ collective view of significant profit growth going forward.  One of those seems wrong.

In the commodity markets, oil (-1.2%) which had a nice bounce yesterday on concerns over Hurricane Francine hitting the Gulf of Mexico tomorrow, has given it all back after the weaker Chinese consumption data.  Meanwhile, metals prices, which also rallied yesterday amid the general good feelings, are little changed overall this morning.

Finally, the dollar is little changed net this morning as the euro has edged down a few pips while the pound has rallied a similar amount.  In fact, in the G10, only NOK (+0.45%) is showing any movement of substance after lower-than-expected inflation data has reduced the probability of further rate cuts by the central bank there.  Amazingly, in the EMG bloc, movements have been even smaller with really nothing of note to discuss amid overall changes of +/-0.2% or less.

On the data front, the NFIB Small Business Optimism Index was released earlier this morning at 91.2, more than 2 points below last month and expectations and an indication that the small business community remains concerned about future economic activity.  There are no speakers and no other data this morning, so I expect the currency markets to do little until after the debate this evening.  If one candidate is particularly effective, we may see some movement, but otherwise, I sense that people are awaiting tomorrow’s CPI for the next catalyst to make a move.

Good luck

Adf