5-Minute Huddle: Roses (Blog)

November 25, 2019

  • 5-Minute Huddle: Roses (2019.11.22)

By Justin Pawl, CFA, CAIA

In this week’s edition:

  • He Said-Xi Said, update. Some progress, but the recent bill passed by Congress may complicate the matter.
  • Roses. Unconventional monetary policy measures are difficult for Central Banks to give up.
  • Eco Data Update. Manufacturing survey data in Europe is improving, and so is the U.S. housing market.

Last Week Today. Christine Lagarde, in her first major speech as European Central Bank President, echoed her predecessor, Mario Draghi, pushing for fiscal stimulus. A bid to jumpstart the world’s second-largest economy in a way that negative interest rates have failed to do. | Speaking of which, the Organisation for Economic Co-operation and Development called for “bold action” from governments to work together to avoid long-term stagnation of the global economy. The OECD’s updated forecasts include economic growth slowing to 2% in the U.S. in the next two years, 1% in the Eurozone and Japan, and 5.5% in China (down from 6.6% last year). | Reports surfaced that brokerage firm Charles Schwab will acquire TD Ameritrade, creating a firm with combined assets of more than $5 trillion.

Financial Markets. Global equity markets softened last week on a lack of progress in U.S./China trade negotiations. Considering the S&P 500 had risen for six consecutive weeks before giving back -0.3% last week, most viewed the short-term pullback as normal market action. International developed market equities (as measured by the MXEA Index), also ended a six-week winning streak, falling by -0.6%. Long-term interest rates declined over the last week, while short-term rates rose a titch, introducing a modest flattening to the yield curve as traders adjusted their fixed income positions for doubts about a trade deal and weak domestic retail sales data.

He Said – Xi Said, update. China’s top trade negotiator, along with China’s President Xi, expressed some low-level optimism about reaching a trade deal. But…. the U.S. Senate passed the Hong Kong Human Rights and Democracy Act by unanimous consent. The House of Representatives passed it by unanimous consent earlier, creating a veto-proof majority. Passage of this bill could lead to sanctions against China and Hong Kong officials and a review of Hong Kong’s trade status with the U.S. What most investors focused on last week was how this bill could complicate U.S./China trade negotiations. However, over the weekend, China (whose current policy is to pay for corporate secrets) announced it has agreed to raise penalties on IP theft. This change in policy may mean that regardless of whether President Trump signs the Act, a Phase I trade deal could be close at hand.

Roses. Minutes from the Fed’s October meeting, where they cut interest rates for the third time this year, offered little in the way of additional information regarding the future path for interest rates. Against a backdrop of what the Fed views as a strong labor market and inflation near their symmetric 2% growth target, they expressed concern about downside risks “associated with global economic growth and international trade” (I think we’re all concerned with this). Officially, monetary policy “likely would remain” where it is “as long as incoming information about the economy did not result in a material reassessment of the economic outlook.” In other words, after cutting rates three times, the Fed is in a wait-and-see mode.

While rates may be on hold, the Fed is engaged in easing monetary policy via adding liquidity to the system. Following the spike in overnight bank repurchase rates (aka, “repos”) in September, the Fed decided to expand its balance sheet to ease funding conditions between banks.


Sources: www.fred.stlousfed.org and Covenant Investment Research.

While the Fed insists the balance sheet expansion is not Quantitative Easing, “A rose by any other name, would smell as sweet,” this is monetary easing no matter what they label it. Indeed, the Fed’s balance sheet bottomed at about $3.8 Trillion in early September but has since expanded by $260 Billion and is just a touch under where it started this year. With the Fed scheduled to continue purchasing $60 Billion per month in Treasury Bills through the second quarter of 2020, the Fed’s balance sheet could be approaching the pre-2018 level by the time they’re done. Notably, the European Central Bank is injecting €20 Billion per month into its economy, and the Bank of Japan’s balance sheet is expanding as well, leaving only the People’s Bank of China out of the monetary policy easing party. As such, the post-Financial Crisis monetary policy experiment continues.

There are many theories about the long-term impact of elevated central bank balance sheets ranging from calamitous to the new normal. Truthfully, no one knows. The post-Financial Crisis trend toward unconventional monetary policy has not only generated massive central bank balance sheets, but it has flipped the idea of borrowing on its head with countries intentionally adopting negative interest rates… citizens in these countries are paid to borrow money and penalized for saving it. Bloomberg’s John Authers wrote an opinion piece summarizing research on negative rates, which (given the results of the Eurozone and Japan) unsurprisingly finds they do not stimulate growth, weaken currencies, or improve liquidity. In other words, the benefits are difficult to find, and the unwind will be long and painful.

Investors are left to pick their way through these uncharted waters carefully. In a year where none of this seems to matter, and both stodgy fixed income and growth-oriented equities have recorded substantial gains, it’s easy to become complacent. After all, 2019 is a near-perfect mirror image of 2018, in which cash was the best performing asset. Yet, prudent investors will use this time to review their portfolios to ensure they know what they own and why they own it. They will also confirm that their portfolio is adequately diversified to contend with the global crosscurrents that can create unwelcome volatility at any time.

Eco Data Update. A snapshot of important economic data releases from around the world last week:

Euro Area manufacturing sentiment (as measured by the Sentix Index, the red line in the chart below) is turning up; historically, actual manufacturing data has followed shortly after that. However, the Euro Area’s most recent Purchasing Manager Index (PMI) data fell to 50.3, meaning the economy is treading water. We’ll have to wait a bit longer to see if the soft data leads to better hard data.


Source: BlackRock

Housing in the US continues to show signs of a recovery. The National Association of Home Builders Market Index came in at 70 with a good level of respondents reporting improving conditions – up from 60 this time last year. The Census Bureau’s report on Housing Starts and Permits showed that single-family activity is starting to break out to the upside. Single-Family Starts were 936k, highest since January. Moreover, residential building permit applications for October exceeded survey estimates and rose to the highest level since 2007.


Be well, and Happy Thanksgiving to you and your loved ones. I’ll be taking the holiday off from writing, so there will not be a 5-Minute Huddle next week.