Week Ahead Key for Risk

Markets continue to take cues from ongoing optimism on Trade developments as it was announced that Trump is considering delaying the Dec 2019 tariffs earlier this week, as well as Brexit developments. After a turbulent few months of chaotic headlines markets are buoyant and reaching for optimism, no news/”less bad news” is good news this week. It’s been relatively quiet on the data front, but with Aussie shares taking cues from Wallstreet we ended the trading week on a decidedly upbeat tone taking out a weekly high.

US Earnings so far have had something for everyone. For the bulls, the bar has been lowered significantly so companies are beating headline numbers more than historical averages. However, CEOs are continuously guiding lower and estimates for 2020 are being cut aggressively. When we cut through the noise of positive trade headlines to the economic data and company outlooks, the message is clear that the global economy continues to slow, and companies are suffering ongoing margin degradation, weaker demand and trade war woes. At some point, the continuously deteriorating earnings outlook where companies meet a lowered bar each quarter will not be enough to sustain the S&P 500 at these levels. This calls into question the sustainability of the present optimism resounding through markets, particularly once the smoke and mirrors optimism of a partial deal on trade fades.

Growth is still trending lower and incoming data continues to confirm that a bottom has not yet been reached. Green shoots are not visible in the most recent US data with Durable Goods Orders collapsing -5.4% Y/Y overnight. Europe fared marginally better as French manufacturing and services PMIs showed some improvement. But denting that positivity was further indication that the recent manufacturing slump continues to bleed into the services sector as Germany Services PMI ticked lower. As we have previously noted, this dynamic is key to whether the ongoing global slowdown will accelerate or stabilise.

The problem is that the manufacturing sector typically leads the services sector lower, which represents a larger part of the economy and is where the bulk of employment sits, so heightens the impact on consumption and raises recession risk. To date recessionary dynamics in the manufacturing sector has not yet spread into the services sector more broadly, with the impact being limited to trade sensitive services as we have highlighted back in July. But with the ongoing deterioration in services PMIs and retail sales data it appears the risks are increasing, which would deepen the slowdown already under way. This nascent spill over into the services sector puts the so far resilient consumer, currently underpinning the economic expansion, at risk because services is where a larger part of the workforce sits. 

With this backdrop in mind market focus will be set on turn back to central bank easing next week as the FOMC are set to deliver a 25bps rate cut. A 25bp rate cut next week is a done deal in our view, certainly most share that sentiment with market pricing now over 90% odds of another rate cut. But for markets the question will be what the probability of further easing is, with the Fed already meeting the threshold of what would be a mid-cycle adjustment and markets still pricing in another cut by April next year. It is clear that the global slowdown has continued into Q4, so we think another 25bps rate cut in December is on the table. However, the Fed are unlikely to communicate this full easing cycle and instead communicate their data dependence meaning markets will be highly sensitive to the incoming data in November.

With risks tilted to the downside and leading indicators still deteriorating the Fed will find it hard to deliver a hawkish cut. But by the same token with substantial easing already discount in markets and the committee divided on the path of rate cuts delivering a dovish enough message for the markets may also be a hard task.

Fed aside we have a big week of data ready to try the recent optimistic market sentiment. US ISM manufacturing, GDP and non-farm payrolls will be key and locally we have CPI and building approvals. Plus, China manufacturing PMIs towards the end of the week, so plenty of opportunity to test the complacent calm and see volatility return. Any turn in risk sentiment could also see the resilient bounce in the aussie dollar faded by month end if volatility returns and sentiment is dented.