Goldilocks Ignored

In what has been a volatile “risk-on/risk-off” few weeks for global markets, it was the turn of “risk-off” sentiment to prevail last week in the face of continued US-China trade tensions. The arrest of Meng Wanzhou, CFO of major Chinese telecommunications company Huawei (and daughter of its founder and CEO) led to understandable fears that it could undermine the chances of a trade deal early next year. US sabre rattling – with Trump tweeting he’s a “Tariff man” if a deal can’t be reached – no doubt added to the tension, as did reports on Friday that the US was preparing to press charges against some identified Chinese hackers.

In what became a self-reinforcing cycle of negativity, moreover, the risk-off sentiment caused long-term US bond yields to drop, which in turn led to fears of an economic slowdown due a “flattening” of the yield curve. The UK’s Brexit saga was also unhelpful as, for the first time in history, the presiding Government was found “in contempt of Parliament” for not detailing all the legal advice on its complex negotiated “divorce settlement” with the EU. As expected, OPEC also agreed to cut production for at least six months, which could help put a floor under oil prices after recent extreme weakness.

Meanwhile, however, the economic data suggested a “Goldilocks” scenario could be emerging for the US economy, with growth slowing to a more sustainable pace and inflation remaining under control. US jobs growth in November was a bit weaker than expected, though still healthy, while annual growth in wages held steady at 3.1%. There were also growing media hints that the Fed, after likely raising rates on December 19, will water down its tightening bias in its accompanying statement – such as through dropping reference to “further gradual increases” as being necessary to contain inflation. That sets up a potential pause in Fed rate hikes until at least June 2019 (i.e. the Fed could pass on raising rates in March, as it recent quarterly rate hike pattern would have otherwise implied).

In Australia, the week’s highlight was a weaker than expected 0.3% gain in Q3 GDP, dragged down by soft consumer spending. In turn, this led to some speculation that the RBA could cut rates next year. To my mind, however, the GDP report merely proves that measured quarterly economic growth can be choppy (growth was 0.9% in Q2), and some bounce back in Q4 seems likely. That said, the report is consistent with my view that the RBA’s 3%+ growth expectation for 2019 remains overly optimistic (2.5 to 3% is more likely), meaning the RBA will likely leave rates firmly on hold next year.

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US-China trade tensions and the UK Brexit vote are likely to dominate market sentiment this week, with economic data taking a back seat. America’s “good cop/bad cop” routine is likely to keep markets on edge with regard to the chances of a trade deal, while the UK Parliament appears likely to plunge Britain into further uncertainty by voting down the excruciatingly complex Brexit deal. Despite their claims to the contrary, this will likely force the UK Government and the EU into even further 11th hour divorce negotiations.

In terms of economic data, a highlight will be the November US CPI report, which is likely to confirm that inflation remains well contained – a good news “Goldilocks” story that the market is finding it hard to focus on. China’s monthly “data dump” on Friday will also likely confirm its economic slowdown, which perversely should highlight its likely strong desire to strike a trade deal in early 2019.

In Australia, there’s a smattering of economic data, including business and consumer sentiment and housing finance. All up, the data is likely to show sentiment is holding up reasonably well despite an ongoing slowdown in the housing sector.

Have a great week!