Macro-Nutrients: China’s Slowdown Deepens and The Road to Neutral – Are We There?

China’s Slowdown Deepens

We’ve seen mounting evidence of China’s economic slowdown in recent months:

“China Bet Its Economic Future on Consumers, and They Aren’t Spending Enough” (WSJ)

“China’s Economy Flashes New Warning Signs” (WSJ)

“December Early Indicators Show China Slowed for a Seventh Month” (Bloomberg)

China’s economic downturn continued last month adding to growing concerns over President Xi Jinping’s current plans to stabilize the economy and the implications of a trade agreement between China and the U.S. amid an on-going trade war between the world’s two largest economies.

China’s Caixin PMI manufacturing index fell to 49.7 for the month of December, missing consensus estimates of 50.1 according to last week’s report. China’s official NBS PMI manufacturing index also fell in December, slowing from 50.0 to 49.4 as shown in the chart below. Both of December’s latest ISM readings signal the first contraction in China’s manufacturing sector since May 2017 and July 2016 respectively.

Source: Bloomberg L.P., Financial Sense Wealth Management

While the number of days since the 90-day tariff truce made on Dec. 1 narrows, the pressure for a trade agreement continues to mount especially given the fragile economic environment they are in. It seems China is stuck between a rock and a hard place with a weak Yuan (shown below), shaky market confidence and decreasing demand for Chinese exports. According to a recent WSJ article (soft-paywall), “Central Bank Governor Yi Gang told a forum on Thursday that China needs ‘relatively loose’ monetary conditions to counter an economic slowdown, though he said that could affect the yuan’s value.”

Source: Bloomberg L.P., Financial Sense Wealth Management

Trade talks between the two countries continued overnight with the latest news from Beijing that both sides feel more optimistic about coming to an agreement on trade. The Yuan has already strengthened in recent weeks (downward move – circled in red) on news that China could be closer to an agreement which could provide a major catalyst for an economic recovery. A recent Bloomberg article citing Chinese foreign ministry spokesman Lu Kang who said, “There’s a very good chance that we’ll get a reasonable settlement.” Liu, President Xi’s chief economic adviser, is said to meet with Washington’s Robert Lighthizer for further negotiation talks before the end of the 90-day tariff truce.

China’s Slowdown Seeps Into U.S.

The global slowdown continues to be felt here in the U.S. The market needed something to cling on to as it was about to end the first week of 2019 in the red. That is until the market’s big surge on Friday, backed by a positive employment report that supports that the U.S. labor market is still strong.

Last week’s employment report was a bullish breath of fresh air for the markets. Or was it? On the surface, Friday’s report revealed that hourly earnings grew 0.4 percent month-over- month beating estimates of 0.3 percent growth for the month of December showing signs that wages grew faster than expected. Probably the highlight of last week’s report showed that U.S. non-farm payrolls increased by +312k month over month, widely beating market expectations of +177k according the BLS. The Household Survey also showed +142k jobs added in December. One of the only negative headline components of the employment report was the fact that jobless claims (or the number of workers who are now unemployed) rose to a five-month high from 3.7 percent in November to 3.9 percent in December.

However, looking inside the numbers suggests lackluster growth despite all the attractive headline numbers. Looking beneath the surface of last week’s report reveal a couple of things:

  1. While Non-farm payrolls beat expectations by a large margin, the report shows that the largest distribution of job growth were among teenagers (age 18-19) and individuals with only a high-school diploma.
  2. In addition, the Household Survey reveals that the number of people holding more than one job jumped up +117k – accounting for over 80 percent of December’s total employment gain.

Aside from Friday’s employment news, December’s ISM manufacturing index fell to its lowest level in two years. According to last week’s report, the index slowed to 54.1 missing expectations of 57.9 due to slower growth in new orders, production and employment.

Source: Bloomberg L.P., Financial Sense Wealth Management

Last week was another reminder that companies are beginning to feel the pain of a global slowdown - Tim Cook, CEO of Apple released a letter to investors revising first quarter revenue guidance for the company downward based on weaker than expected sales in China year-over year amid China’s economic downturn.

The Road to Neutral: Are We There?

Friday’s big move in the markets was also in response to further dovish comments from Fed Chairman Jerome Powell in a roundtable discussion with his predecessors Janet Yellen and Ben Bernanke at the American Economic Association’s annual meeting in Atlanta last Wednesday, Jan. 2.

Three weeks ago on Dec. 19 marked the Fed’s fourth quarter-point rate hike of 2018 which preceded an even steeper decline in global asset in the last weeks of 2019. In Friday’s televised roundtable, Powell made several telling comments that could signal how the Fed may approach monetary policy in 2019.

Powell indicated plans will be more data-dependent and flexible regarding future policy decisions. “As always, there is no preset path for policy… and particularly with muted inflation readings that we’ve seen coming in, we will be patient as we watch to see how the economy evolves” Powell said.

Other noteworthy comments came amid the recent disappointing economic data in housing and manufacturing which have pointed to signs of slowing economic expansion. Powell said that overall the economy still looks strong but noted that markets are pricing in “downside risks” taking note of the slowdown in China. He added that the market is, “well ahead of the data” but promised that “we’re listening very carefully”.

Source: Bloomberg

With the current Fed Funds rate at 2.4 percent, the market’s implied probability of another single 25 basis points rate hike this year is currently around 20 percent with a 64 percent probability that they remain neutral as shown circled above. The probabilities of two hikes are now just north of two percent.

Since the Fed’s last policy decision in December, consensus among FOMC officials seems to predict two rate hikes this year, however, our thought is that the Fed may have already reached neutral as Financial Sense Wealth Management’s Chris Puplava, CIO recently outlined in his most recent article, To Pause or Not to Pause: That Is The Question. This week is a big one for monetary policy expectations with tomorrow’s release of the FOMC’s December meeting minutes and a scheduled speech from Jerome Powell on Thursday at the Economic Club of Washington. In the days ahead, we will look for further insight regarding current financial conditions and the market’s recent correction.

About the Author