Markets Send Mixed Signals on Trade Battle
June 16 2019 - 6:59AM
Dow Jones News
By Akane Otani and Gunjan Banerji
Markets are sending conflicting signals about how big a threat
the global trade rift presents, underscoring the difficulty
investors face in sizing up the fallout from the U.S. and China's
spat.
As the trade standoff has intensified and the Federal Reserve
has suggested its next move might be a rate cut, some investors
have turned to safer assets, sending Treasury yields to their lows
for the year. But relatively risky assets like stocks have
continued to climb toward fresh highs, with the S&P 500
finishing Friday just 2% off a record.
Investors also haven't rushed to take out protection in the
options market against potential declines -- a somewhat unusual
development, since stocks tend to fall alongside bond yields when
investors believe the economy is heading toward a soft patch.
Yields fall as bond prices rise.
One yardstick measuring stock swings, the Cboe Volatility Index,
has fallen 40% in 2019, on pace for its biggest annual decline in a
decade. Volatility measures tracking crude oil and currencies have
also dwindled this year.
The disconnect between markets points to lingering debate among
investors about just how much the U.S. and China's trade fight will
hit consumer spending, investment and other key drivers of economic
growth.
"Who's right? I want to go with the bond market at this point,"
said Zhiwei Ren, a portfolio manager at Penn Mutual Asset
Management. "I don't see equities making significant new
highs."
Mr. Ren has bought shorter-dated bonds in anticipation of the
Fed cutting interest rates. He added that he doesn't see a trade
truce between the two largest global economies coming soon.
The Fed will conclude a two-day policy meeting Wednesday, where
it is expected to hold interest rates steady and potentially offer
clues about the likelihood of future rate cuts.
Although the central bank had at the end of 2018 signaled it was
likely to raise rates this year, it has since retrenched. Fed
Chairman Jerome Powell in early June said the central bank could
cut rates if the trade spat causes a deterioration in the economic
outlook. Now, investors have priced in a roughly 30% chance of two
rate cuts and about a 38% chance of three rate cuts by the end of
the year, according to CME Group, up from 24% and 6% respectively
in mid-May.
With the Fed hinting it is willing to step in and cut interest
rates if necessary, some investors say it is still too early to
slash bets on U.S. stocks. That is especially true because economic
data haven't shown a recession on the horizon: The Labor
Department's latest employment report showed that the U.S. jobless
rate hovered at a half-century low, though the pace of hiring
slowed. Corporate earnings are also expected to grow at a
single-digit percentage pace this year overall, according to
FactSet -- a slower pace than in 2018, but not the rollover that
some had feared heading into the year.
The Fed's posturing shows "they're not asleep at the wheel,"
said Jim Tierney, chief investment officer of concentrated U.S.
growth at AllianceBernstein. Mr. Tierney's fund, which holds large
positions in shares of companies like Microsoft Corp. and
Mastercard Inc., has risen 25% this year -- outpacing the S&P
500's 15% gain. "What that does is it takes the disaster scenario
for equities off the table."
Still, others warn it may not be wise to assume that trade
tensions will have a limited impact on consumers or to bet that the
Fed will slash rates.
"We have an idea of how tariffs will affect inflation and GDP,
but what's uncertain is how does that impact companies, consumers
and stock volatility...and that's where we come into a lot of
uncertainty," said Saira Malik, head of global equities at Nuveen,
which has been trimming exposure to risky assets since the U.S.
stock market rallied in the spring.
Commerce Department data in May showed even though U.S. economic
growth was robust in the first quarter, consumer spending slowed. A
measure of U.S. household sentiment also fell in May from earlier
in the month, weighed down by expectations of increased tariffs
pushing prices higher.
"There are significant headwinds that markets aren't pricing
in," said Alexis Crow, who leads PricewaterhouseCoopers's
geopolitical investing practice.
Nervousness has showed up in the bond market, where investors
have been placing bets on interest rates falling. The yield on the
10-year Treasury note has fallen this year and settled at its
third-lowest level of 2019 on Friday.
Bond funds investing in relatively safer debt recently recorded
strong inflows, according to Deutsche Bank AG. Investors also
ramped up bullish bets on eurodollar futures, a derivative used to
bet on central-bank moves, increasing positions that pay out if
rates fall, according to the firm.
Either way, many feel the current disconnect between the bond
and stock markets is unsustainable. Fresh economic data ahead could
spur one market to converge with the other.
"This divergence cannot last," said Mandy Xu, an equity
derivatives strategist at Credit Suisse Group AG.
Write to Akane Otani at akane.otani@wsj.com and Gunjan Banerji
at Gunjan.Banerji@wsj.com
(END) Dow Jones Newswires
June 16, 2019 07:44 ET (11:44 GMT)
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