The Global Economic Doctor

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Markets Searching for Direction – Caution Is the Word of the Day

May 6, 2016

Summary:  Global equity and debt markets continue to seek a clear direction, but economic data and earnings are sending contradictory signals.  This leaves a situation in which investors want to assume risk and push markets up, but they have one eye to the door in case bad news disrupts shallow confidence and starts a nervous stampede.  The reasons for this state of affairs are numerous – uneasiness over the strength of global economic growth, yet another poor earnings season (the 4th in a row), geopolitical risks, and big questions over Fed policy (will it raise rates in June or not?).  The US April jobs report did not help matters: unemployment stayed at 5.0% and the 160,000 print on jobs was below expectations. We think this leaves the Fed holding off at their June meeting, but moving later in the year, possibly in September.

We expect investors to remain cautious, adding risk strategically. One indicater of caution about direction is that gold prices (and gold miners like IamGold, Kinross Gold and Yamana) have been on the rise. They have benefited from growing uncertainty over the global economy and the geopolitical calendar. Caution is also mirrored by U.S. 10-year Treasury yields remaining low at around 1.78%. Consequently, caution is the word of the day and this sentiment is likely to increase as we shift gears past the earnings season to the political season beginning in June. (See last item below)

  • US employment data: Initial claims for state unemployment benefits increased 17,000 to a seasonally adjusted 274,000 for the week ended April 30.  This was the largest increase since February 2015.  However, the next day’s April jobs report disappointed as the U.S. economy added the fewest number of jobs in seven months. Nonfarm payrolls rose by 160,000 jobs last month, with a marginal increase in construction and a downturn in retail employment. Unemployment remained constant at 5.0%, but that was due to Americans dropping out of the work force. Furthermore, employers added 19,000 fewer jobs in February and March than previously reported.  One of the few bright spots in the April jobs report was a slight uptick in wages. Based on this report and other mixed data as well as a looming Brexit vote two weeks (June 23rd) after the scheduled June FOMC meeting, it appears that the U.S. central bank might put off a rate increase to September.
  • Fitch Pans negative interest rates: Fitch rating agency released a study in which it noted that the almost $10 trillion of negative yielding government bonds are costing investors about $24 billion annually.  This situation is raising challenges to investors, such as pension funds and insurance companies that rely on sovereign debt as a core area for their portfolios.  If nothing else, the adoption of negative interest rates forces investors to take on riskier assets or provide their clients with poorer returns.  At the same time, negative interest rates punish savers and retirees.  Moreover, it is dubious that negative interest rates are encouraging economic growth.  It does not seem to be working in Japan. More to come on this.
  • Markets and US Politics:  Now that Donald Trump and Hillary Clinton have emerged as their respective parties candidates, there is growing talk about how the two will impact markets. The dominant view (at least based on opinion polls and a lot of talking heads in the financial press) is that the Democratic candidate is likely to win and would probably be more market-friendly as she represents the least amount of change in policies. As this line of reasoning goes, markets hate uncertainty and Trump represents uncertainty.  The American Banker has been up front saying it does not know what a Trump presidency would mean for the financial industry, while exporting companies are deeply worried that protectionism and efforts to re-write trade treaties (like NAFTA) would be highly disruptive.  At the same time, Washington has been highly dysfunctional over the past 8 years and change is badly needed, which would probably play more to Trump than Clinton. Markets have yet to factor in the outcome of the US November election, but that will change once we move past the conventions and head into the fall season. Stay tuned.
  • Japan Weaker, Weaker: Japan’s economy continues to be a weak patch. The Markit/Nikkei Japan Services Purchasing Managers Index (PMI) fell to 48.9 in April from March’s 49.9.  This is significant in that services account for roughly 65% of Japan’s GDP as opposed to 21% for manufacturing. The recent spate of bad economic data indicates the pressing need for more fiscal policy and structural reforms as opposed to the heavy reliance on monetary policy to lift the economy.
  • Turkey’s Power Plays: Turkey’s Prime Minister, Ahmet Davutoglu, announced that he would be stepping down from his position.  The Prime Minister and President Erdogan have been bumping heads over how much power their respective offices have.  In the past, the constitution gave greater power to the prime minister, with the president serving in largely ceremonial role.  However, Erdogan has increased the authority of the presidency and dominates the political landscape.  It has been reported that the two leaders increasingly held differences over the opening of talks with Kurdish separatists, the appointment of an independent central bank governor, and relations with the European Union.  With Davutoglu out, Erdogan remains the undisputed power in Turkey, which means that Turkey’s policies could be less friendly to the European Union, more hardline vis-à-vis the Kurds and even less tolerant of opposition voices. Last, but hardly least, the ongoing political drama undercuts Turkey’s attractiveness for investment.
  • Brazil’s Ratings Down, Again: Fitch downgraded Brazil from BB+ to BB and maintained a negative outlook.  As the rating agency noted: “The continuing deep economic contraction reflects the high level of political uncertainty, depressed confidence, deteriorating labor markets and strong external headwinds. Medium-term prospects also appear subdued, as the country’s investment rate has fallen in recent years and microeconomic reforms to improve competitiveness and the business environment have not made material process.”  More political drama looms ahead as the Senate moves next week on whether to investigate President Dilma Rousseff for a possible impeachment, an action that would suspend her from office.  Brazilian ratings remain under pressure and one should approach the country’s securities with a degree of caution.

The Looming Political Season:  Looking for uncertainty, look no further than the following votes:

May 9, 2016   Philippine Presidential elections

May 11, 2016   Expected date for the Senate vote in Brazil to advance investigation into whether or not to impeach the President

May 15, 2016   Dominican Republic – Presidential, congressional and local elections

May 22, 2016   Turkey – the ruling AK party will hold an extra-ordinary congress to select a new party leader and prime minister

June 23, 2016   UK – Referendum on whether or not to remain in the European Union

June 26, 2016   Spain goes to the polls again after the last vote (December 2015) failed to result in a government

June 30, 2016   Iceland presidential vote

September 18, 2016   Russian parliamentary elections

November 8, 2016   US presidential and congressional election


Dr. Scott B. MacDonald

Chief Economist

MacDonald Scott b

      Dr. Scott B. MacDonald is Chief Economist at Smith’s Research & Gradings.
      Prior to this, he was Senior Managing Director and Chief Economist at KWR International, Inc (KWR). Prior to KWR he was the Head of Research for MC Asset Management LLC, an asset management unit of Mitsubishi Corporation based in Stamford, Connecticut (2012-2015) and Head of Credit & Economics Research at Aladdin Capital (2000-2011) and Chief Economist for KWR International (1999-2000). Prior to those positions he worked at Donaldson, Lufkin & Jenrette, Credit Suisse and the Office of the Comptroller of the Currency (in Washington, D.C.).
      He did his Ph.D. in Political Science at the University of Connecticut, Masters in Asian Studies at the University of London’s School of Oriental and African Studies, and BA in History (Honors) and Political Science at Trinity College (Hartford). He has written 18 books and numerous articles. Areas of expertise are macroeconomics, international finance and geopolitical risk.


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