This week in the markets


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Markets buffeted by yield curves and trade talk

August 16, 2019   

Global equities lurched up and down this week, reacting to developments in the ongoing U.S.-China trade war, and Wednesday’s brief inversion of a key U.S. treasury yield curve – the latest in a growing list of economic and financial indicators warning of the rising possibility of recession. The volatile trading – which included the worst day yet this year for Canadian and U.S. equities – left all major developed stock markets with losses for the week and yields on government bonds at or near all-time lows. In the typical pattern of a flight-to-safety, other safe haven assets rose, including gold and the U.S. dollar.

The week began with markets focused on turmoil in the geopolitical landscape: Argentina, India-Pakistan, Brexit, Italy, and especially the unrest in Hong Kong, which threatens the territory’s role as an economic gateway to Asia. Then an unexpected announcement by the U.S. that it will delay tariffs on some Chinese goods until December sparked a strong rally in stocks and oil prices.

The optimism from de-escalating trade tensions lasted less than 24 hours. The inversion of the U.S. two-year/10-year curve (meaning the yield on 10-year treasuries dipped below that on two-year government bonds) added to investors’ concerns that the U.S.-China trade war was taking a toll on global economic growth. Weaker economic data from Germany and China helped fuel the “risk-off” attitude. The resulting plunge in stock prices more-than-erased the previous day’s rally. As the S&P/TSX Composite and S&P 500 indices declined, defensive, interest rate-sensitive “bond proxy” sectors (e.g., utilities, real estate, staples) performed best in both markets.

While the yield curve inversion and the market’s reaction to it clearly indicate an elevated level of concern for the economic outlook, it is important to keep it in perspective. The yield curve is not a perfect recession predictor and many other indicators suggest a near-term recession is still unlikely. Growth is slowing in many regions of the world, mainly due to trade disruptions. But most global central banks are cutting interest rates to stimulate growth or signalling rate cuts are coming. In the U.S., consumer spending and confidence remain strong, which is not surprising considering unemployment and inflation are low. Initial jobless claims – arguably a more reliable recession predictor than the yield curve – are stuck near all-time lows, and if employment remains tight and consumption strong, a recession is unlikely. This week’s U.S. economic data should provide some comfort. Among the stronger-than-expected numbers were positive surprises in key manufacturing surveys and rising retail sales.  

The yield curve has never before inverted while yields were this low, so take any reference to historical patterns with a grain of salt. But historically, even when the yield curve has correctly foretold a recession, it has been with a lead time on average of 15 months, and a minimum of 10 months. In the time between the initial inversion and subsequent S&P 500 peak, equities have typically advanced another 12%, more than the average decline post-peak, meaning market timing is a difficult and probably a money-losing strategy.

 

What’s ahead next week:

Canada

  • Manufacturing sales (June)
  • Consumer Price Index (July)
  • Retail sales (June)

U.S.

  • Existing home sales (July)
  • Markit Purchasing Managers Indices (August)
  • Conference Board Leading Index (July)
  • New home sales (July)

This weeks market closing values

EQUITY INDICES Level Change 1-week YTD 1-year 5-year
      CAD CAD CAD CAD
S&P/TSX 16,149.79 - 191.55 - 1.17% + 12.76% - 0.47% + 1.08%
S&P 500 2,888.68 - 29.97 - 0.61% + 12.32% + 2.61% + 12.47%
DJIA 25,886.01 - 401.43 - 1.11% + 8.17% + 2.20% + 13.60%
FTSE 100 7,117.15 - 136.70 - 0.78% - 1.66% - 9.07% - 1.14%
CAC 40 5,300.79 - 27.13 - 1.13% + 5.81% - 2.38% + 5.09%
DAX 11,562.74 - 131.06 - 1.74% + 3.41% - 6.92% + 5.12%
Nikkei 20,418.81 - 266.01 - 1.56% + 3.21% - 3.11% + 9.34%
Hang Seng 25,734.22 - 205.08 - 0.37% - 3.08% - 4.10% + 4.42%
CURRENCY RETURNS CAD Change 1-week YTD 1-year 5-year
US$ 1.3272 + 0.0050 + 0.38% - 2.68% + 0.88% + 4.02%
Euro 1.4720 - 0.0090 - 0.61% - 5.86% - 1.65% + 0.16%
Yen 0.0125 - 0.0000 - 0.24% + 0.34% + 5.19% + 3.23%
CANADIAN TREASURIES Yield Change COMMODITIES USD Change
3-month 1.63 + 0.00 Oil $54.89 + $0.39
5-year 1.20 - 0.06 Gold $1,513.34 + $21.03
10-year 1.15 - 0.12 Natural Gas $2.19 + $0.10