October was the worst month for U.S. stocks since 2011, with the S&P 500 Index tumbling 6.94 percent.
October was the worst month for U.S. stocks since 2011, with the S&P 500 Index tumbling 6.94 percent. After taking such a beating, it’s safe to say that traders are probably a bit desperate and prone to overreact to any bit of good news. That was on full display Thursday, as the S&P 500 was quickly heading south following a disappointing report on U.S. manufacturing — but then came the tweet.
Stocks quickly erased their losses and rose 1.06 percent when, just eight minutes after the Institute for Supply Management released its monthly report on manufacturers, President Donald Trump tweeted that he “just had a long and very good conversation with President Xi Jinping of China.”
The tweet went on to say that the talks had “a heavy emphasis on trade,” with those discussions “moving along nicely.” No one outside of Trump or his inner circle knows what constitutes “good” or “moving along nicely,” and maybe the tweet was another example of the president employing his “truthful hyperbole” strategy.
But the reaction by traders suggests they want to believe that cooler heads will prevail, and that Trump and Xi will soon end their escalating trade war in a manner that is agreeable to both sides, because it looks like it’s starting to have a real impact on corporate America.
Just had a long and very good conversation with President Xi Jinping of China. We talked about many subjects, with a heavy emphasis on Trade. Those discussions are moving along nicely with meetings being scheduled at the G-20 in Argentina. Also had good discussion on North Korea!
— Donald J. Trump (@realDonaldTrump) November 1, 2018
The ISM’s factory index dropped to 57.7 for October, a six-month low and down from 59.8 in September. Digging into the numbers, the part of the report that tracks export orders fell to its lowest since November 2016, while prices paid jumped more than expected. Normally, that would raise concern about profit margins being squeezed.
There was also a decline in the ISM survey’s breadth, with 13 of 18 industries reporting an increase in business activity, down from 15 last month and the least since January 2017. “Import tariffs and counter-tariffs are the biggest inhibitor to the expansion in manufacturing” and trade strains are “restricting demand,” Timothy Fiore, the chair of ISM’s manufacturing survey committee, told Bloomberg News. Right now, traders are starved for any bit of good news. But the question is, how long will tweets sustain them amidst an economy that is showing signs that growth has peaked?
Bond trader complacency
The bond market isn’t concerned about inflation all that much. Breakeven rates on five-year U.S. Treasuries — a measure of what bond traders expect the rate of inflation to be over the life of the securities — dropped on Thursday to 1.87 percent, the lowest of the year. That’s partly due to the recent drop in oil prices as well as the notion that economic growth is starting to slow. But don’t be surprised if there’s a swift rethinking of the outlook for inflation on Friday, when the government releases the monthly jobs report.
That’s because average hourly earnings are forecast to show an increase of 3.1 percent in October from a year ago, which would be the first time the number breached the 3 percent mark since 2009. There’s no shortage of economists who feel that the sluggish earnings growth of recent years despite a steadily declining unemployment rate has been the primary reason why inflation has remained below the Federal Reserve’s 2 percent target. After all, consumers aren’t going to pay higher prices for goods and services if their compensation isn’t growing.
That could be changing: A government report earlier this week that showed the employment cost index, a broad gauge monitored by the Fed, increased 2.8 percent in the third quarter from a year earlier, matching the second quarter as the fastest gain since 2008. Whatever the outcome, bond traders are looking somewhat complacent.
Oil’s supply glut
Speaking of oil, crude tumbled to its lowest since April on Thursday, falling to as low as $63.11 a barrel. As recently as last week, prices were approaching $77 a barrel, and analysts were talking about how $100 was a possibility. But they seemed to have failed — again — to correctly gauge the response of OPEC.
The 15-member group boosted crude production to the highest level since 2016 as increases by Saudi Arabia and Libya offset losses stemming from impending U.S. sanctions on Iran, according to Bloomberg News’s Grant Smith. They increased output by 430,000 barrels a day to 33.33 million in October, according to a Bloomberg survey of officials, analysts and ship-tracking data.
Since the summer, their policy has reversed to what Saudi Arabia’s energy minister last week described as “produce-as-much-as-you-can mode.” It’s important to remember that Trump has put pressure on the kingdom to pump more, even threatening the military alliance between the two countries that’s underpinned the balance of power in the Persian Gulf for decades.
That’s important now, because the drop in oil has helped reduce gasoline prices to their lowest since March, something Trump may elect to tweet about as one of his major accomplishments ahead of the midterm elections next week.
As recently as the start of this week, it seemed as if currency traders were giving up the U.K. pound for dead. The Bloomberg Pound Index, which measures the currency against a basket of developed-market peers, was trading at some of its lowest levels since August 2017 as the Brexit negotiations slogged along with no apparent good ending in sight.
All that changed on Thursday, with the Bloomberg Pound Index soaring as much as 1.41 percent for its biggest gain since April 2017. The reversal in sentiment was spurred by comments from the Bank of England that signaled a faster pace of interest-rate hikes and reports that a Brexit deal has been reached for banks. It didn’t really matter that British and European officials denied the Brexit story — traders know that neither side wants to reach the March deadline for negotiations and have nothing to show for them but a “hard” exit that could disrupt economies and markets globally.
Moreover, the BOE wouldn’t be so hawkish if policy makers felt a Brexit resolution wasn’t likely at some point. “We remain confident a deal will be struck and think investors should prepare for the Monetary Policy Committee to lift rates twice next year,” Bloomberg Economics wrote in a research note after the BOE meeting.
Sri Lanka crisis
It’s not often, if ever, that the goings-on in Sri Lanka have the potential to impact global markets, but this may be one of those extremely rare times. The company’s sovereign bonds have tumbled, with prices on $1.25 billion of debt issued earlier this year slumping to less than 87 cents on the dollar this week as its rupee fell to an all-time low of 175.80 against the dollar.
The declines follow a warning from the speaker of Sri Lanka’s parliament that the country could descend into political violence if the legislature remains suspended. Sri Lanka has debts of $15 billion maturing between 2019 and 2022, but the real issue is the balance of power in the region.
Colombo has been gripped by political intrigue since President Maithripala Sirisena suspended parliament and said he had to fire Prime Minister Ranil Wickremesinghe because of an assassination plot, replacing him with former president and strongman Mahinda Rajapaksa.
The surprise return of Rajapaksa, who took billions of dollars in Chinese loans to fund infrastructure projects, prompted concerns that Sri Lanka might again move closer to Beijing rather than maintain close ties with India and other democracies, Bloomberg News reported. Emerging markets are always interesting.
The Labor Department releases its monthly jobs report on Friday, and the median estimate of economists surveyed by Bloomberg is that 200,000 jobs were created in October, in line with the average over the past five years. Still, that estimate is really just a shot in the dark, as the results are likely to be distorted due to hurricanes. The high estimate among the more than 70 economists surveyed by Bloomberg News is for a gain of 270,000 jobs, while the low estimate is an increase of 90,000 jobs.
The recovery efforts from Hurricane Florence are likely to have boosted hiring in sectors such as construction, while Hurricane Michael should have depressed activity in Florida and Georgia, according to Bloomberg Economics. In short, there is sure to be lots of volatility in markets even if the headline number comes in close to expectations.