Weekly multi-asset desk views

Weekly review: 4 October 2019

Weekly Mag updates

Summary

  • Weakness in manufacturing appears to be spilling over into the services sector
  • The chance of the Federal Reserve (Fed) cutting rates at its October meeting has increased significantly due to poor data

Market and economic review

Market moves this week were driven by two disappointing activity surveys in the US, which we will go on to talk about in more detail. Equities posted negative returns, with losses more prominent in developed markets. Unsurprisingly, government bond yields fell throughout the week as the slowdown in manufacturing seems to be spreading to services.

Weakness in manufacturing appears to be spilling over into the services sector

The main story this week was a very disappointing manufacturing ISM print from the US released on Tuesday. As a reminder, the August print declined into contractionary territory for the first time since August 2016, and the consensus for September was a rebound back to 50.0. The headline print was a decade-low 47.8, a 1.3 decline from the previous reading. Underneath the surface, weakness was most noticeable in production (47.3) and employment (46.3). Equity markets reacted poorly to the news and posted negative returns on the day; however, the majority of the week’s losses occurred on Wednesday. On that day, the S&P 500 dropped by -1.8% and the Euro Stoxx 50 by -3%. Government bond yields took a sizable leg lower. This more than offset the move higher in global yields on Tuesday, triggered by poor demand in a Japanese government bond auction.

For some time, we have been concerned that the weakness in manufacturing may take a toll on services. Having observed that those factors become more correlated over time, the question remains of what comes next: a recovery in manufacturing or deterioration in services? On Thursday, the non-manufacturing ISM and composite numbers were released, which indeed showed further evidence that poor manufacturing data is spreading. The non-manufacturing reading was 52.6 vs. an expected 55.0, and a previous month reading of 56.4. Equity markets initially continued their downward move; however, this more than reversed as the day traded towards close. In contrast, the rally in government bonds faded any retreat.

On the same theme, the remainder of the eurozone PMIs were released throughout the week and continued to undershoot expectations. In manufacturing, Spain (47.7 vs. 48.2 expected), Italy (47.8 vs. 48.1 expected) and France (50.1 vs. 50.3 expected) disappointed, which helped drag the overall eurozone composite down to 50.1, vs. an expected 50.4. Similarly to the US, the weakness in manufacturing taking a toll on services was evident, causing the economic outlook to deteriorate.

The chance of the Fed cutting rates at its October meeting has increased significantly due to poor data

After the disappointing ISM data during the week and uninspiring non-farm payroll numbers on Friday, the market now expects a further cut to the Federal Reserve Effective rate at their October meeting. Based on market pricing, the probability of a cut has almost doubled from 40% to 79% since the beginning of this week. With just two meetings left this year, the probability of two cuts is now just over 50%.

Outlook

Next week is relatively light on the data front, with trade talks between the US and China taking centre stage. Chinese Vice Premier Liu He is due to fly to Washington for talks, with the most recent news suggesting that both sides are adopting a more constructive tone. With that in mind, markets will be very sensitive to any developments.

The main data we are due to receive comes in the form of US CPI and PPI reports, the results of which could apply further pressure on the Fed ahead of its October meeting. With that in mind, it will be interesting to look out for any commentary released from Fed speakers.

Across the Atlantic, news from Europe will likely be dominated by Brexit headlines as UK Prime Minister Boris Johnson attempts to drive through an agreement deal on the UK’s departure from the European Union. Meanwhile, a flurry of data from Germany by way of industrial production and factory orders prints may add further fuel to the growth-uncertainty flames.

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