Global Confidence: Shake, Rattle, Roll?

Mid Week Bond Update

Global Confidence: Shake, Rattle, Roll?

In the current market turmoil, how will the disparity between business and consumer confidence get resolved?


The week’s heightened rhetoric surrounding trade and politics is a reminder that the fears of market participants can quickly overwhelm fundamentals in the short run. That said, wavering confidence can be useful in reframing how we view those fundamentals -- a dynamic that may apply to the current disparity between consumer and business confidence in the world’s major economies, both developed and otherwise.

As in the U.S., consumer confidence in the rest of the developed world (and much of the developing world as well) has surged over the past year or two, reflected in robust retail sales figures.  For example, overall U.S. retail spending for the second quarter of 2019 rose at a 7.5% annualized rate – suggesting that the U.S. consumer is spending confidently.

But confidence among businesses has been trending in the opposite direction, something that has happened only rarely over the past three decades as noted by Brandywine Global’s Jay McIntyre.
 

A Short Term Mismatch of Confidence

Chart courtesy of Brandywine Global. Sources: OECD, Haver Analytics, as of June 30, 2019.  Past performance is no guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

Of course, this must now be seen through the lens of investors’ changing perceptions of the impact of trade tensions. But causes for general optimism abound as well. Over and above retail sales, employment has been strong and wages show signs of steady growth. Interestingly, optimism among U.S. small businesses also remains relatively high. But that suggests business confidence faces bigger challenges within larger multinationals and trade-focused corporations.

On the rise: Safe Haven: Japanese Yen?

At an intra-day high1 of 105.5 Japanese yen per U.S. dollar, Japan’s currency has yet to scale the heights of 2011-2012, when the European financial crisis drove it to as high as 75.35 per dollar.

But the early August 2019 high was nevertheless a significant upward move (3.5%) from the July 31 2019 intra-day low of 109.3 per dollar, the apparent result of several cross-currents over the intervening five days. The list includes long-unresolved trade grievances between Japan and South Korea, ongoing disagreements between China and the U.S., and growing uncertainty around the resolution of Brexit.

While not all exerting pressure in the same direction, the need for a safe haven for currency traders while trade issues muddy the waters elsewhere could be overwhelming the regional issues facing Japan.  The next question: Will the yen revert if the China-U.S. trade conflict cools down again?
 

On the slide: U.S. 10-year Treasury Yields

November 8. 2018 saw the yield of the 10-year Treasury hit a multi-year high of 3.237%, and the debate among bond investors was whether whether that yield could rise further, bringing to an end the long bull market in bonds.

On August 5 of 2019, that yield reached 1.6705%, a fall of about 158 basis points. Of that fall, 40 basis points2 took place in the four days between the end of the Fed’s July 31 2019 rate cut meeting and an interim spike in China-U.S. trade and currency tension on August 5 2019.

It’s clear that some of the fall since the Fed meeting was driven by unexpected deterioration in the tone of negotiations between the U.S., and China, including the surprise declaration by the U.S. Treasury Department that China would officially be deemed a “currency manipulator” – a reversal of agreements made during previous U.S. – China negotiation sessions.

At present, it appears that one of the world’s largest and most liquid fixed-income markets is in the grip of a sudden sweep of bearish sentiment about global growth.  But whether the current record yields in this portion of the yield curve can hold over the longer term as the U.S. prepares to issue bonds to support its deficit spending, remains to be seen.


All data Source: Bloomberg as of August 6, 2019 unless otherwise specified.


Footnotes:

1 Source: Bloomberg, August 6, 2019, 7:00 AM Japan time

2 Source: Bloomberg, August 5, 2019, 6:00 PM ET
 

Definitions:

The Organization for Economic Co-operation and Development (OECD) is an international organization that promotes policies to improve the economic and social well-being of people around the world.

The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

One basis point (bps) equals one one-hundredth of one percentage point.

U.S. Treasuries are direct debt obligations issued and backed by the "full faith and credit" of the U.S. government. The U.S. government guarantees the principal and interest payments on U.S. Treasuries when the securities are held to maturity. Unlike U.S. Treasury securities, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the U.S. government. Even when the U.S. government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.

 

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