- 10-year breakeven rate falls to 3-year low and provides support for T-notes
- Trump administration tries to dial-back fears of Chinese stock restrictions
- PM Johnson plans to submit legal text of Brexit agreement late this week
- U.S. ISM manufacturing index expected to show a modest recovery
10-year breakeven rate falls to 3-year low and provides support for T-notes — The 10-year breakeven inflation expectations rate on Monday fell to a new 3-year low of 1.484% although it then partially recovered and closed the day -1.3 bp lower at 1.520%. The breakeven rate measures the difference between the nominal and TIPS 10-year Treasury securities. Monday’s decline in inflation expectations gave the T-note market some support. Dec 10-year T-notes closed -2.5 ticks although the 10-year yield closed -1.6 bp at 1.665%.
The 10-year breakeven rate in the past two weeks has fallen sharply by about -20 bp from the mid-Sep 2-month high of 2.706%. That high was caused by the upward spike in oil prices that resulted from the Sep 14 attack on Saudi Arabia’s key oil facility. A key factor that drives 10-year inflation expectations is oil prices as seen by the close correlation between the two measures. Nov WTI crude oil prices on Monday fell sharply by -3.4%, helping to push the 10-year breakeven rate to the new 3-year low.
After the initial upward spike in oil prices seen on the Sep 14 strike on Saudi Arabia’s oil facilities, oil prices have since fallen sharply and are now below the level seen just before the Sep 14 strike. That strike initially knocked out about half of Saudi Arabia’s oil production and about 5% of world oil production. However, Saudi Arabia has been able to bring its production back online much more quickly than expected. Aramco, Saudi Arabia’s national oil company, said on Monday that it has restored Saudi production to 9.9 million bpd.
Aside from the impact of oil prices, the 10-year breakeven inflation expectations rate has been undercut in recent days by expectations for weak U.S. and global economic growth tied in part to trade tensions and U.S. political uncertainty. Indeed, the German Sep CPI (EU harmonized) on Monday eased to a 2-3/4 year low of +0.9% y/y from Aug’s +1.0% and sank farther from the ECB’s inflation target of just under 2%.
The recent decline in the 10-year breakeven rate, however, flies in the face of the recent uptick in the U.S. inflation data. The U.S. Aug CPI rose to an 11-year high of +2.4% y/y and showed an even larger +3.4% rise on a 3-month annualized basis. Meanwhile, the Aug core PCE deflator rose to an 8-month high of +1.8% y/y and is now only 0.2 points below the Fed’s 2.0% inflation target. The markets seem to be attributing the recent rise in the inflation statistics to one-off effects from tariffs as opposed to a fundamental monetary-based rise in inflation.
Trump administration tries to dial-back fears of Chinese stock restrictions — The stock market on Monday was somewhat mollified by the Trump administration’s partial denial that it is planning investment limits in Chinese stocks. The Treasury issued a statement saying that there are no current plans to stop Chinese companies from listing in the U.S. However, that didn’t constitute a denial of other elements of Bloomberg’s report last Friday that the Trump administration is considering such measures as (1) delisting Chinese companies listed in the U.S., (2) limiting exposure of American investors to the Chinese markets through government pension funds, and (3) putting limits on whether U.S. index firms can include Chinese stocks in their indexes.
For his part, White House trade advisor and chief China hawk Peter Navarro, appearing on CNBC, broadly denied the Bloomberg report as “fake news” but then went on to say, “There’s some significant issues related to Chinese stocks listed on public exchanges. There’s some interesting and significant transparency issues with Chinese stocks, but that’s all I’m going to say, I’m not going to talk about what’s going on behind closed doors.”
Last Friday’s news that the Trump administration is discussing restrictions on U.S. investment in Chinese stocks makes next week’s high-level trade negotiations even more important. If President Trump is not happy with next week’s talks, he will undoubtedly go ahead with the upcoming tariff hikes and he might also announce restrictions on U.S. investment in Chinese stocks, which would expand the US/Chinese economic war to the capital markets. The markets are well aware that the Chinese government holds $1.1 trillion of Treasury securities and could cause havoc in the U.S. markets if it starts unloading some or all of that position.
PM Johnson plans to submit legal text of Brexit agreement late this week — Bloomberg on Monday reported that the Prime Minister Johnson’s government late this week on either Thursday or Friday will submit its Brexit proposal to the EU in the form of a draft legal text. The fact that the proposal has already been turned into legal text indicates that Mr. Johnson is farther along on trying to get a new Brexit deal than the markets generally thought. However, there are still no obvious ways to satisfy both the EU and the UK Parliament on a Brexit withdrawal agreement, meaning the odds of success for a new Brexit agreement by Oct 31 remain slim.
U.S. ISM manufacturing index expected to show a modest recovery — The market consensus is for today’s Sep ISM manufacturing index to show a +0.9 increase to 50.0, recovering nearly half of August’s sharp -2.1 point decline to a 3-1/2 year low of 49.1. The index in August fell into contractionary territory below 50.0 for the first time since early 2016. The ISM manufacturing new orders sub-index in August fell by -3.6 points to 47.2 and is in even weaker shape than the headline index, showing a paltry orders pipeline.
Indeed, U.S. manufacturing production in August fell by -0.4% y/y and is down by -1.1% so far this year, indicating that the U.S. manufacturing sector is already in a recession.
