Long bond yield hits all-time low
During the short trading week last week, U.S. bond yields plummeted in risk-averse trading with the long bond leading the drop. Amidst an equity sell-off due to U.S. Presidential Election and coronavirus (COVID-19) concerns, the 30-Year closed Friday at an all-time low of 1.91 [Figure 1]. Since then, and as of this writing, it’s fallen even further.
Given that markets now expect the Fed will cut interest rates twice this year, this is a marked change from the optimism we saw late last year as the Phase One trade deal was being finalized. On the plus side, the fall in interest rates is supporting the U.S. housing market and potentially unlocking savings for the consumer via lower mortgage payments.
Defensives led as equities declined in volatile trading
Equities had a tough week last week, and this week may not be much better as the S&P 500 opened on Monday down 3.2%. Despite last week being a strong one for the Chinese equity markets (SHSZ300 +4.1%), emerging markets was the laggard (MXEF -2.0%) while U.S. Markets (SPX) and International Developed Markets (MXEA) both ended down 1.2% on the week.
While U.S.-focused defensives led at the sector level, some of the market’s favorites — like growth, tech, and large caps broadly — had a rocky week. We believe this reflects risk reduction and not necessarily a new trend.
U.S. flash PMI falls, services in contraction
On economic growth, forward-looking Flash PMIs (Purchasing Managers’ Index) painted a mixed picture. Europe appears to be improving, while Japan hit new cycle lows and may be at risk of entering a technical recession; its GDP fell at an annualized rate of 6.3% in Q4.
But the big story was the material fall in the U.S. Composite PMI, which since the global financial crisis has only contracted one other time, during the government shutdown in 2013. Weakness was driven largely by U.S. Business Services (approximately 85% of the U.S. economy), which fell below 50 for the first time in four years. The forecasting firm IHS Markit reports that the deterioration is due partly to supply chain disruptions and weakened demand across sectors like travel and tourism, likely due to coronavirus1.
Interestingly, companies also reported potentially pulling back on spending due to uncertainty ahead of the U.S. presidential election and fears of a wider economic slowdown. Paradoxically, the Future Output Index rose materially in the same report. While IHS Markit’s report is widely followed, it’s not yet collaborated by other U.S. data. That said, it certainly has our attention.
Long-held correlations breaking down
While the CBOE Volatility Index (VIX) rallied and the U.S. dollar strengthened, especially against Emerging Markets, something odd appears to be occurring in major macro barometers, including the U.S. dollar, the Japanese yen, Gold, and U.S. treasuries: long-held correlations are breaking down. Even as the U.S. dollar has strengthened, so too has gold, when historically the two have had an inverse relationship. Gold, in particular, is soaring on coronavirus fears and its spot price may be poised to reach a level not seen since 2012 [Figure 2].
Though it’s not clear what the breakdown in correlations means, it could be that investors believe, both, that the U.S. may potentially be less impacted by coronavirus, and also that the Fed may need to embark on another cycle of easing. Already, there are almost two full cuts priced in by the end of the year, with the first full one expected by the June meeting.
Will concerns about coronavirus and US politics intensify or will investors buy the dip?
This week, we’ll be watching whether concerns about coronavirus and U.S. politics intensify — or if investors come back in to “buy the dip” as they have so many times since early 2019.
Fear of Coronavirus pandemic: We’re entering a new stage with the coronavirus, as talk of a pandemic grows louder. We’re seeing local transmission and the virus’ spread is broader than first thought. China has again, and for the third time, revised its methodology for counting infection rates, feeding into a lack of trust about infection rate numbers. Investors remain concerned, as reports of supply chain disruptions and the total number of cases worldwide increase. Markets will be keeping a close eye on rates of infection, and how well containment efforts work, not just in China but also in currently affected countries like South Korea, Japan, Italy and Iran.
U.S. presidential politics impacting markets: U.S. politics are finally impacting markets — and not in a good way. Given Bernie Sanders’ strong showing in the Nevada caucuses, and Mike Bloomberg’s poor performance in last week’s debate, the Democratic nomination is looking like Bernie’s to lose. Nominees will debate again on Tuesday, with the next primary in South Carolina on February 29th. Bernie’s performance is making investors nervous and, according to the popular BAML survey, the “Outcome of the 2020 U.S. Presidential Election” is now the “biggest tail risk.”2 And the betting market PredictIt currently has Bernie at a 65% chance of winning the nomination, up 15 points in the past week.
U.S. personal income and other data coming out this week: We’ll be watching the Eurozone confidence survey coming out on Thursday. China’s PMI and Japanese retail sales and industrial production come out on Friday. U.S. personal income and spending will be released on Friday as well.
To download a copy of this commentary and the chart of the week click the button below.