Just when investors thought it may be safe to jump back into the water, with the U.S. benchmark stock indexes DJIA, +0.06% SPX, -0.01% again close to new highs after September economic data mostly surprised to the upside, this week’s data so far has done nothing for what the economist John Maynard Keynes called “animal spirits”.
A gauge of employment in U.S. service industries pointed to job losses for the first time in almost a decade, adding to signs of a cooling labor market, according to data published Monday. The preliminary IHS Markit services purchasing managers’ index (PMI) for employment fell to 49.1 in September, the lowest since December 2009, from 50.4 the prior month. Readings below 50 indicate contraction. However, the overall U.S. services sector PMI rose to 50.9 from 50.7, while a similar index for manufacturing advanced to a five-month high of 51.
But the employment data suggest U.S. job gains will slow further, after the four-month average of hiring at companies fell to the lowest since 2012. “Firms have become more risk averse and increasingly eager to cut costs,” IHS Markit chief business economist Chris Williamson said. “At current levels, the survey employment index is indicative of nonfarm payroll growth falling below 100,000.”
Monday’s data followed US industrial production data for August last week showing a rise of 0.6%, the most in a year as crude oil production bounced back from Hurricane Barry’s impact on drilling in the Gulf of Mexico a month earlier, but that was not enough to improve the deteriorating annual trend which showed a mere 0.4% year-on-year growth, the weakest since January 2017.
The U.S. fiscal tailwinds of tax cuts, deregulation and extra spending have been no match for trade dispute headwinds, LPL Financial chief investment strategist John Lynch wrote.
Across the Atlantic, the economic data was much worse on Monday. Growth in the euro-area economy almost ground to a halt at the end of the third quarter amid evidence that the manufacturing slump is spreading to the services sector. The IHS Markit purchasing managers index for the 19-nation region fell to 50.4 in September, down from 51.9 a month earlier, and the weakest in more than six years, suggesting euro-zone economic growth of just 0.1% in the third quarter.
The signs of deepening malaise come less than two weeks after the ECB rolled out new monetary stimulus measures including an interest rate cut to even more negative levels and a restart of its bond-buying program. The package could yet turn out to be insufficient, according to Markit. “The details of the survey suggest the risks are tilted towards the economy contracting in coming months,” Markit economist Chris Williamson, said. “With survey data like these, pressure will grow on the ECB to add to its recent stimulus package.”
The U.S. – China trade dispute, which has disrupted global supply lines and undermined business confidence, and the prospect of Britain’s departure from the European Union without a deal, are the main factors causing euro-area factories to suffer their sharpest decline in output since 2012.
Germany’s economy is suffering its worst downturn in almost seven years as a manufacturing slump deepens. Factory activity shrank at the fastest pace in a decade in September and growth in services softened, according to the monthly report by IHS Markit. “The manufacturing numbers are simply awful,” IHS Markit economist Phil Smith said of Germany. “All the uncertainty around trade wars, the outlook for the car industry and Brexit are paralyzing order books, with September seeing the worst performance from the sector since the depths of the financial crisis in 2009.”
See also: Global economy growing at slowest pace since recession, OECD says
U.S. consumer to the rescue ?
With weaker manufacturing data and mixed business confidence, the focus is on the consumer as the main prop for U.S. economic growth, as consumer spending accounts for more than two thirds of GDP.
The US consumer continues to be a bright spot in the outlook and though the labor market data, on balance, has softened, wage and salary income has slowed only slightly, up 5.2% over the 12 months through July 2019 compared with 5.3% over the prior 12 months, Morgan Stanley equity strategist Michael Wilson wrote.
This picture of stronger labor compensation presents a mixed bag for the US outlook though, Wilson argued. “On one hand, it has supported above-trend spending and kept measures of consumer attitudes elevated, but on the other hand, it also corroborates the findings of our equity strategists that businesses have had to digest much higher labor costs than the more closely followed metrics such as average hourly earnings would have investors believe. This has increased margin pressure as top-line growth slows, contributing to the earnings recession the US is experiencing now.”
See also: We are in an earnings recession, and it is expected to get worse
Trump’s trade war remains the dark cloud on the horizon
St. Louis Fed President James Bullard on Monday said the U.S. economy is at risk because the 75-year old era of free-trade, which has helped American companies expand around the world, is ending. The global economy is “going to have to transition to this new reality that trade won’t be as free as it was,” Bullard told reporters after a speech in Illinois.
Unfortunately, this week may bring yet more evidence of the ways in which President Trump’s trade policies are undermining the rules-based global economy. Trump is expected to sign a trade deal with Japan which may alleviate some of the pain suffered by U.S. farmers as a result of his China trade war by opening up the lucrative Japanese market to some American agricultural exports. It will also include commitments on digital trade and tariff reductions, but will exclude autos which means the deal won’t comply with World Trade Organization rules requiring bilateral deals between members to apply to the vast majority of trade between signatories.
The irony here is that this week’s limited U.S. – Japan trade deal was necessitated by Trump’s decision to pull out of the more comprehensive Trans-Pacific Partnership (TPP), which included Japan and 10 other U.S. trading partners, concluded in 2016. And Trump’s deal is based on the agricultural concessions and digital rights the Obama administration spent years negotiating with Japan for the TPP anyway.
Central banks out of ammunition ?
In a report on Sunday, the Bank for International Settlements (BIS), or the central bankers’ bank based in Basel, Switzerland noted that recent monetary policy by the Fed, ECB, and China’s PBOC has pushed yields lower across the world, leading to more than $17 trillion in negative-yielding tradeable bonds.
Negative interest rates have reached “vaguely troubling” levels and the effectiveness of monetary policy is waning to the point it might not be able to counter the next global downturn, said Claudio Borio, Head of the Monetary and Economic Department at the BIS.
“The room for monetary policy maneuver has narrowed further,” he said. “Should a downturn materialize, monetary policy will need a helping hand, not least from a wise use of fiscal policy in those countries where there is still room for maneuver.”
Borio also warned about the corporate debt market, especially imbalances in leveraged loans known as collateralized loan obligations (CLOs) which “represent a clear vulnerability” to the global financial system.
While central banks can encourage consumers and businesses to spend or invest by making it cheaper to borrow, by historical standards interest rates are already low or negative. Borrowing by households and businesses is already at high levels, and the U.S. government’s budget deficit is heading towards levels seen after the 2008 financial crisis as a result of Trump’s 2017 tax cuts.
“We’ve got to think much harder, for economic stabilization, about mechanisms that involve spurring demand directly,” Lawrence Summers, a former U.S. Treasury secretary and current Harvard University professor, said in a recent interview.
One solution is to let central banks create money to finance government budget deficits, according to a recent paper published by asset manager BlackRock Inc. and co-written by Stanley Fischer, the Fed’s former vice-chair.
The challenge, say the BlackRock authors, is to embed such “historically unusual’’ measures in explicit rules, so that central bankers retain their independence, and can apply the brakes if government spending gets out of control.
“When you have the next downturn, quantitative easing isn’t going to be as effective, interest rates aren’t going to be effective,’’ Ray Dalio, founder of Bridgewater Associates LP, the world’s biggest hedge fund, said recently. “Then you need fiscal policies and debt monetization,’’ he said. “We’re going to enter a new realm.’’
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