Market Looking to Powell for Policy Guidance as China Announces New Tariffs

A highly anticipated speech from Fed Chairman Jerome Powell is scheduled for a little later this morning. Given how jittery the market has been with the Treasury yield inversions and recession fears, ultra-low longer-term U.S. government debt yields, and continued worry about the trade war, today could end up being a volatile session.

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Key Takeaways

  • Futures market expecting 25-basis-point rate cut in September

  • Market could be volatile following Fed chief’s comments

  • Manufacturing reading falls to lowest level in nearly a decade on Thursday

(Friday Market Open) A highly anticipated speech from Fed Chairman Jerome Powell is scheduled for a little later this morning. Given how jittery the market has been with the Treasury yield inversions and recession fears, ultra-low longer-term U.S. government debt yields, and continued worry about the trade war, today could end up being a volatile session.

Speaking of the trade war, China fired the latest salvo, saying it will slap new tariffs on another $75 billion in U.S. goods on Sept. 1 and Dec. 15. If you’ll recall, those are the dates when U.S. tariffs on $300 billion in Chinese goods are scheduled to take effect.

The trade war has been worrying investors for some time now as a possible headwind toward global economic growth. That’s partly why the market is hoping for more policy easing from the Federal Reserve, and it’s one of the reasons investors will likely be paying close attention to Powell’s speech this morning. 

On Thursday, the futures market showed a 93.5% chance of a 25-basis-point rate cut at the Fed’s meeting next month, and the rest of the probability was for no change. That’s a pretty big contrast to just a week prior when the market showed a 31.5% chance that the central bank might cut rates by a more-aggressive 50 basis points, and 68.5% chance of a 25-basis-point cut. Odds then were zero of the Fed standing pat on rates. 

While a 25-basis-point cut is still accommodative, the market appears to be thinking the Fed will be less dovish than investors had been hoping. We’ll have to see whether the futures market reacts to this morning’s speech by Powell, and if so how. 

Mixed Signals From Fed Officials

Hawkish comments from Federal Reserve officials on Thursday appeared to be behind the rise in expectations that the central bank will keep rates unchanged, from zero chance, to “slight possibility,” though by this morning the probability of a 25-point cut rose to 99.6%. Those  hawkish comments also helped push Treasury yields higher, and the yield on the 2-year note surpassed that of the 10-year note again.

Kansas City Fed President Esther George told CNBC that she believed a rate cut wasn’t required last month. And Philadelphia Fed President Patrick Harker told the news outlet that he doesn’t see the case for another cut at the upcoming meeting. 

Still, what the Fed actually ends up doing isn’t a foregone conclusion. Dallas Fed President Robert Kaplan was more dovish than his two colleagues, saying in an interview on CNBC that he is open-minded about the possibility of cutting the Fed’s key rate further in the next couple of months.

Manufacturing in Contraction Territory

On Thursday, data from IHS Markit showed its U.S. manufacturing  purchasing managers index fell to its lowest level in nearly a decade in August. The reading of 49.9 for the initial reading indicated the manufacturing sector contracted during the month.

One thing that remains to be seen is whether the manufacturing number will bounce back or if the sector will remain in contraction territory.

A softening manufacturing sector would give the Fed more of a reason to cut rates, but central bankers may want to see more data on the subject or weigh other factors since one data point probably wouldn’t sway the central bank’s thinking.  

Trading in all three of the main U.S. indices was relatively muted. The S&P 500 (SPX) ended just 0.05% lower while the Dow Jones Industrial Average ($DJI) rose a smidge and the Nasdaq Composite (COMP) fell a bit. Volumes were on the light side.

Market participants may have been holding off on making big trades to wait and see what Powell has to say today. 

In economic data a little later this morning, investors are scheduled to see new home sales for July. A Briefing.com consensus is expecting a seasonally-adjusted headline figure of 645,000. That’s about steady with June. One thing to watch beyond the headline, however, is any downward revisions to previous months. That’s what happened in the June report when sales for March, April, and May all got revised lower. 

FIGURE 1: VIX FLATTENS: While the Cboe Volatility Index (VIX), which is the market’s main fear gauge, rose more than 5% to more than 16 on Thursday, investors don’t appear to be as nervous as they have been in recent days when the VIX was above 20. Data Source: Cboe Global MarketsChart source: The thinkorswim® platform from TD AmeritradeFor illustrative purposes only. Past performance does not guarantee future results.  

The Market and the Economy: It’s been said before, and we’ll say it again: The market isn’t the economy. Sure, the market responds to economic data, but the market can also be irrational or simply respond to other stimuli than the flow of data. One disconnect that seems to have appeared in recent months is that the main U.S. indices can sometimes seem like they’re performing more poorly than the general economy. That’s probably mostly due to worries about future economic growth in light of the trade war, or the market’s mood about what it thinks the Fed might do with its interest rate policy. But overall, it might be helpful to remember that while the U.S. economy isn’t going gangbusters, it’s also not doing too badly, based on GDP, the jobs market and signs of strength from the U.S. consumer. 

Moderate Economic Expansion Expected:On Thursday, the market got another piece of data that seems to contribute to the narrative that the economy in general is OK despite the gyrations of the stock market. The Conference Board Leading Economic Index increased by 0.5% in July, surpassing expectations in a Briefing.com consensus that had forecast a 0.2% gain. Although the manufacturing sector continues to exhibit signs of weakness, housing permits, unemployment insurance claims, stock prices and the Leading Credit Index were the main drivers of the improvement, the Conference Board said. So what does this mean going forward? “While the LEI suggests the U.S. economy will continue to expand in the second half of 2019, it is likely to do so at a moderate pace,” according to the Conference Board. 

Dividend Growth Slows: Dividend payouts are often considered a characteristic of healthy companies. But while dividend payments have been on the rise, the growth rate is slowing, offering yet another indicator that companies overall are OK, but not great. The latest Janus Henderson Global Dividend Index showed that global dividends were up 1.1% in Q2 compared with a year ago. Total payouts of $513.8 billion marked a Q2 record but also represented a sharp slowdown from the year-ago period, when total dividends grew by 14.3%, as payouts were held back by a stronger U.S. dollar. “The deceleration in the world economy, and its associated impact on corporate profits, has begun to make an impact on dividends,” according to Janus Henderson Investors. 

In North America, dividends hit a record $132.9 billion on the back of double-digit growth in Canada. But U.S. dividend growth slowed to 3.9%, which marked the smallest increase in two years. Still, more than 80 percent of U.S. companies increased their dividends, representing a larger proportion than in many other large countries.

Good Trading,

JJ

@TDAJJKinahan

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This week's economic calendar. Source: Briefing.com
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Key Takeaways

  • Futures market expecting 25-basis-point rate cut in September

  • Market could be volatile following Fed chief’s comments

  • Manufacturing reading falls to lowest level in nearly a decade on Thursday

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