Covenant Weekly Market Synopsis for May 3, 2019

May 6, 2019

Last Week Today: China’s manufacturing PMI unexpectedly fell to 50.1 in April (from 50.4 in March) coming dangerously close to 50 – the threshold marking expansion or contraction. | President Trump and top Democrats (including Pelosi and Schumer) outlined a $2 trillion infrastructure plan focused on improving mass transit and expanding broadband systems. Bipartisan anything is a rarity in D.C. these days, but the problem is how to fund the program. | A big, busy week for economic data and below we highlight the Good, the Bad and the Ugly.

The end of April marked the fourth consecutive month of positive performance for global equities as reduced trade tensions and more dovish central banks buoyed risk assets. For specific weekly, month-to-date and year-to-date asset class performance, please click here.

However, as you are waking up this morning, the U.S./China trade deal has hit a rough patch, and global equities are selling off anywhere from -6% (China) to -2% (U.S. and Europe). Headlines are changing quickly, so anything I write now will be out of date by the time you read it. Suffice to say that if the U.S. and China fail to seal a trade deal, an outcome that has already been largely priced into equities, today’s sell-off will morph into something more serious.

Fed Update… Nothing is less. The Fed made no change to current interest rates in their third of eight meetings this year… no surprise. However, in the post-meeting press conference Chairman Powell caught the market off-guard, or perhaps “offsides” is a more appropriate term, when he made several remarks indicating that the Fed is on hold, despite falling inflation (see chart below) that many investors believed would result in a rate cut later this year.

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The same “patient” stance that investors rewarded in January during the Powell pivot from hawkish to dovish was punished as investors voted with their wallets causing the S&P to decline by nearly 1% from the intraday highs. The problem with the Fed’s decision is that if they are genuinely following their recent commentary of a symmetrical approach to monetary policy (i.e., treating the 2% inflation target as an average rather than a ceiling that should be avoided) they would be cutting rates now as inflation moves further away from the vaunted 2% level.

It’s entirely possible (and unfortunate) that politics is playing a role in the Fed’s inaction. The Wall Street Journal’s Nick Timiraos shares this concern “Cutting rates could be complicated coming after President Trump has called repeatedly for the Fed to do so. Central bank officials have said politics never influence their decisions. But Mr. Trump’s comments would put more pressure on them to explain any policy changes so that doubts about their independence don’t erode their credibility in the markets.” If anywhere close to accurate, the President (who is in favor of easier monetary policy) is his own worst enemy publicly calling for rate cuts and more Quantitative Easing.

Eco Data Update. It was a busy week for economic data releases.

The Good

  • Productivity, as measured by output per worker hour, jumped to 3.6% in Q1. On a year-over-year basis, productivity rose 2.4%, which is the fastest late-cycle growth rate since the Greenspan-led Fed allowed the economy to run above potential in the late 1990s. Higher productivity is a buffer against higher inflation and enables real wages to increase as well.

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  • The April jobs report showed robust hiring, adding 263,000 new jobs. The unemployment rate fell from 3.81% to 3.59%, a new low for this business cycle.

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Source: FTN Financial

  • Unfortunately, some of the decline in the unemployment rate was due to a reduction in the labor force participation rate from 63.0% to 62.8%. As a result, the broader measure of unemployment (the U-6 rate) and the best predictor of wage growth, held steady for the third consecutive month at 7.3%.

The Bad

  • April’s ISM Manufacturing survey fell to 52.8 (from 55.3 in March), marking a 2.5 year low:
    • New orders fell from 57.4 to 51.7, lowest since December.
    • Production fell from 55.8 to 52.3, lowest since Aug 2016.
    • Employment fell from 57.5 to 52.4, lowest since Feb.

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Source: FTN Financial

  • The ISM non-Manufacturing survey declined modestly from 56.1 in March to 55.5 in April.
  • The MNI Chicago Business Barometer recorded its lowest reading in two years, dropping from 58.7 in March to 52.6.

The Ugly

  • Auto Sales (annualized) fell from 17.5 million in March to 16.4 million in April.
  • Within the ISM Manufacturing survey, the export and import orders sub-indices fell into negative territory, highlighting the real-world impact of trade tensions.

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Bottom Line: Overall economic activity is plateauing, which is not surprising following the unsustainable 3.2% growth rate in Q1. The Atlanta Fed’s GDP Now algorithm is pointing to Q2 GDP growth of 1.7%. We don’t pretend to be good enough to forecast with that level of specificity. Directionally, however, it fits our expectations that GDP growth is headed back to the post-Financial Crisis trend rate of 2% – 2.5%, which is good, but not great growth.