We’re officially on slowdown watch

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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.

Good morning. For a moment early yesterday it looked like everything was going perfectly: Nvidia was down but the market still managed to edge higher. The afternoon was less ideal, but still the S&P 500 ended flat after the biggest and most hyped company in the world’s report didn’t meet expectations. Maybe there is hope after all. Email us: robert.armstrong@ft.com and aiden.reiter@ft.com. 

Slowdown watch

The jobs numbers for August will be released a week from today — the single most important economic data release before the Federal Reserve’s September meeting. While the comically brief recession panic of a few weeks ago is over, market pundits and macroeconomists are debating how quickly the economy is slowing and how much rate-cutting will be required. Here’s how we see the main moving parts.

The labour market is weakening, but at a stately pace. Initial jobless claims, which have been on a slow rising trend all spring and summer, have stopped increasing in the past three or four weeks. That’s good news, but we remain a little spooked by the slow pace of hiring and the falling rate at which workers are working up the confidence to quit their jobs. Both employers and employees are cautious.

GDP growth for the second quarter was revised up from 2.8 per cent to 3 per cent, while the job numbers from the past year were revised down by 818,000. We are nowhere near recession, but the job market is now a bit too cool for comfort.

Vibes in markets are mostly good. Earnings season was solid overall, despite the usual bumps and bruises. This sentiment was confirmed this week with the release of second-quarter corporate profits from the national accounts, which rose almost 2 per cent from the first quarter.  

At the same time, though, investors are buying defensive stocks — utilities have led all sectors in the past month, and healthcare and consumer staples have also beaten tech stocks. Gold, long seen as a hedge against market decline, is at record highs. Somebody is spooked about something.

Consumers are doing OK, except at the low end. As we wrote about last week, the US consumer is broadly doing well. Consumer giants like Walmart and Target had good earnings reports in which executives explicitly called out the resilience of consumers. Big consumer brands and travel companies did well, too.

Low-income consumers continue to struggle though. McDonald’s had a shaky quarter. Pepsi and Mondelez have spoken about finding the right price to keep price-sensitive consumers buying. And yesterday discount retailer Dollar General gave a bleak outlook, describing its core customers as “financially constrained”.

The second-quarter household debt report from the New York Fed showed things getting little better. And our favoured measure of stress among poorer, younger consumers is car loan delinquencies. It’s not looking great for all age groups, but its especially bad for 18-29 year olds:

To us, as for Jay Powell, it’s not time to panic, but it is time for a rate cut.

(Armstrong and Reiter)

China’s counterintuitive bond purchases

The People’s Bank of China continues to intervene in the country’s bond market — in confusing ways. Chinese banks and investors, short of safe investment options, have piled into long-dated bonds, driving yields to historic lows and prices to record highs. The Chinese government is not happy about this. The PBoC initially borrowed bonds from banks and sold them in the secondary market, and cracked down on bond trading. The signal: stop buying bonds. It didn’t work. Bond yields went up for a few days, and then resumed their downward slide:

The PBoC said the interventions were designed to ensure financial stability, but as we discussed last week, that doesn’t make loads of sense. This week, things became weirder still.

On Wednesday, the PBoC announced that it bought Rmb300bn ($42bn) worth of 10-year notes and Rmb100bn of 15-year notes from primary dealers. One does not generally drive the price of something lower, and thus the yields up, by buying a lot of it.

But the FT reports that the move was normal central bank balance sheet management — at least in timing and structure. There was shorter-term debt on the PBoC’s balance sheet about to expire, and the central bank replaced them, but using longer maturities. “The ministry of finance has just placed these bonds with PBoC. There was no secondary market impact at all. In other words, it was a rollover operation,” said Mark Williams at Capital Economics.

Messaging from the PBoC suggests that the purpose of rolling over those bonds was for future market interventions. The PBoC mostly holds short-term debt, and in the last intervention they had to borrow longer-term securities. It seems they are now building a reserve to sell into the market when the PBoC wants to push the long end of the yield curve up.

But as the PBoC’s initial attempt showed, interventions that fly against economic fundamentals tend to fail. China’s interest rates are low and its growth outlook is soft — good reasons for investors to buy bonds, despite warnings from the authorities.

The PBoC is being pulled in multiple directions. The Chinese Communist party said it wanted to increase domestic consumption in July, and the PBoC responded by lowering rates. When lower rates helped spur a bond rush, the PBoC had to intervene in the market because yields fell too low. Last year the central government cracked down on local government debt, but now there are reportedly plans for the PBoC to issue a new round of financing to local governments. All of this speaks to an unresolved policy tension between pivoting towards domestic consumption and sticking with the export-driven growth strategy that has served the country so well. 

The PBoC does not have the political independence needed to prioritise among divergent policy goals. Consistency and clarity, on the bond market and everything else, will have to flow from above.

(Reiter)

One good read

T-shirts and de-globalised supply chains