Date: October 5, 2018
Will U.S. Economic Growth Dip, or Will the Rest of the World Catch Up?
An important issue facing the global economy and markets in the final quarter of the year is divergence—the widening economic and policy differences among advanced economies as U.S. growth outpaces that of Europe and Japan. The next few months will also shed light on a second crucial issue—how these divergences will ultimately be reconciled. Will the U.S. lose momentum, dragged down by slow global growth and/or a loss of domestic policy momentum at home? Or will Europe and Japan gain speed and converge with the U.S.? These questions raise consequential issues well beyond financial markets, affecting the prospects for trade wars, currency turmoil in emerging economies, the path for orderly normalization of monetary policy in the advanced world, and, in the political realm, the future of anti-establishment movements and polarization. Since the end of 2007, and including International Monetary Fund projections for 2018, gross domestic product in the U.S. has expanded a cumulative 17.1 percent, compared with 11.6 percent in Europe and 6.7 percent in Japan. The initial phase of U.S. outperformance resulted mainly from bigger problems in other parts of the advanced world, particularly in Europe, where the debt crisis dragged down economic activity. Then followed a short period of synchronized expansion and, most recently, a pickup in the U.S. as both consumption and business investment responded to tax cuts and deregulation—a policy-induced boost that the Federal Reserve expects to last for up to three years.
U.S. Trade Gap Hits Six-Month High as Soybean Exports Plunge 28%
The U.S. trade deficit widened in August to the biggest in six months as soybean exports plunged and a measure of the gap with China hit a record, showing how the Trump administration’s trade war is dragging on economic growth. The gap in goods and services trade increased 6.4 percent to $53.2 billion, from a revised $50 billion in the prior month, Commerce Department data showed Friday. Imports rose 0.6 percent and exports fell 0.8 percent. Soybean exports dropped $1 billion, or 28 percent, to $2.58 billion, reversing a run-up earlier this year ahead of retaliatory levies from China. A widening trade deficit is set to drag on the economy in the third quarter after a narrower gap helped boost the pace of expansion in the prior period to the fastest since 2014. The latest figures show how President Donald Trump’s tariffs on goods from China and other nations, which have raised prices and disrupted some businesses, are starting to weigh on an otherwise solid pace of U.S. growth. The median estimate of economists surveyed by Bloomberg called for a trade deficit of $53.6 billion. Preliminary figures last week had showed a wider trade gap in merchandise. Exports fell to $209.4 billion, spanning declines in other items including crude oil and petroleum products. Imports rose to $262.7 billion, boosted by consumer goods and automobiles. Friday’s report showed the unadjusted merchandise-trade gap with China, the world’s second-biggest economy, widened to a record $38.6 billion, from $36.8 billion. The trade deficit with Mexico was a record $8.7 billion, following $5.5 billion.
U.K. Bond Yields Rise to Two-Year High on Divorce-Deal Optimism
The yield on U.K. government bonds climbed to the highest level in more than two years amid growing optimism that a Brexit deal will be reached. The pound advanced for a second day and gilts slid after a Reuters report said sources within the European Union see a divorce deal with the U.K. as “very close,” although traders who asked not to be identified said the pound gains came under thinner-than-average trading volumes. The gilt sell-off could continue into next week, according to Mizuho International Plc, with the debt-management office having announced a syndicated bond sale as a global selloff in government debt looks set to continue. “We would expect that gilts remain under some bearish pressure next week, as it seems likely to us that Ireland’s backing of the U.K. being allowed into a customs union with the EU will carry weight with the other EU27 members,” said Peter Chatwell, head of rates strategy at Mizuho. “Moreover, the long-end gilts supply will probably keep the curve in a steepening bias until the bonds are absorbed.” The 10-year gilt yield rose one basis point to 1.68 percent as of 12:07 p.m. in London, after reaching 1.71 percent, the highest since January 2016. The pound was 0.1 percent higher at $1.3040, having climbed as much as 0.3 percent. Benchmark gilt yields have jumped 10 basis points this week, set for the biggest increase since August, as domestic political risk faded after Prime Minister Theresa May survived her party’s conference unscathed and several reports suggested both sides in the Brexit talks are open to compromise.
India Bonds Rally After Central Bank Holds Rates in Surprise Move
India’s rupee declined and stocks entered a correction after the central bank kept interest rates unchanged, surprising investors who expected the authority to step up its defense of Asia’s worst-performing major currency. The Reserve Bank of India held the repurchase rate at 6.5 percent, a decision forecast by just nine of 49 economists in a Bloomberg survey, and changed its stance to “calibrated tightening” from neutral, signalling more increases lie ahead. The pause after back-to-back hikes since June puts the central bank behind counterparts in Indonesia and the Philippines, which have taken aggressive steps to support their currencies amid an emerging-market rout triggered by higher U.S. rates and a stronger dollar. Soaring oil prices and the tumbling rupee have pushed India’s benchmark yields to near a four-year high and erased more than $300 billion in value from equities since August. “The decision to keep rates unchanged when the rupee is touching fresh lows raises a lot of questions,” Gaurang Shah, chief investment strategist at Geojit Financial Services Ltd. in Mumbai, said by phone. “The macro environment remains challenging and the persistent pressure from oil prices raises doubts over the sustainability of any recovery.” The S&P BSE Sensex tumbled 2.3 percent at the close, the most since February. The gauge has slumped about 12 percent from its August record. The rupee slid to a new record low, falling past the 74 to a dollar mark, before closing down 0.3 percent to 73.7650. The 10-year yield fell 13 basis points to 8.03 percent. Mumbai-based traders said that the state-owned lenders likely stepped in on behalf of the RBI to stem the rupee’s slide after the policy decision. “The unchanged decision suggests that the RBI is not overly concerned about rupee depreciation,” said Mitul Kotecha, a senior emerging-markets strategist at TD Securities in Singapore. “The initial reaction in bonds will be positive but yields will likely struggle to move below 8 percent.”
India’s Central Bank Delays the Inevitable
When the world’s de facto central bank rustles up an interest-rate whirlwind, you don’t use a fig leaf of flexible exchange rates to stand in its path. That memo, already well-received in Indonesia, doesn’t seem to have reached India. The Reserve Bank of India chose to hold its policy interest rate at 6.5 percent on Friday. And by delaying the much-debated quarter-percentage-point increase, policymakers signalled their tolerance of financial instability. That was an unwise decision. Until recently, the mandarins in New Delhi had muddled the message by hinting they were comfortable with a weaker currency, as long as the RBI softened the decline by selling dollars from its $400 billion war chest. Such sangfroid, less than a year before the next general election, was just bravado. A record-low rupee was only going to lead to a vicious cycle of costlier imported crude oil; fatter fuel-subsidy bills; bigger concerns about an already-bloated budget deficit; higher bond yields; a more desperate flight of investors from equity and debt markets; and an even weaker Indian currency. It was only when those consequences became clear – amid a liquidity squeeze exacerbated by the collapse of an infrastructure lender – that the authorities perhaps stopped and thought, “Gee, we can’t prevent this juggernaut, only the Fed can.” It should be obvious that the end of the U.S. tightening cycle isn’t nigh, with Federal Reserve officials saying that the long-term neutral rate is somewhere between 2.5 percent and 3.5 percent, and the short-term equilibrium rate even higher.