- Expectations for Fed easing reach new high while partially inverted yield curve fuels recession talk
- China saber-rattles with threat to cut-off of rare-earth exports to U.S.
- China’s manufacturing PMI is expected to slip back below 50
- U.S. economic reports expected to be mixed
Expectations for Fed easing reach new high while partially inverted yield curve fuels recession talk — The markets have now talked themselves into discounting nearly three rate cuts by the end of 2020 even though the Fed has not yet made any admission that it might be leaning towards even one rate cut in coming months. The federal funds futures contract on a yield basis on Wednesday fell by another -4 bp to 1.640%, which represents market expectations for an overall -71 bp rate cut (i.e., 2.8 rate cuts of 25 bp) by the end of 2020 from the current IOER rate of 2.35%.
Meanwhile, the 10-year T-note yield on Wednesday continued to slide and fell to a new 1-3/4 year low of 2.21%, although the yield then rebounded higher to close the day just -0.5 bp lower at 2.261%. The 10-year T-note yield has fallen sharply by -27 bp since the US/Chinese trade talks effectively collapsed on May 6. Since that collapse, President Trump raised the tariff to 25% from 10% on $200 billion of Chinese goods and blacklisted Huawei, China’s second-largest technology company.
Meanwhile, the yield curve has flattened in the past several weeks as long-term yields fell faster than short-term yields. The 2s10s spread on Tuesday fell to a 2-month low of 14.1 bp and then rebounded mildly higher to 15.2 bp on Wednesday.
The yield spread between the 10-year T-note and the 3-month T-bill has dropped like a stone in the past two weeks and hit a 12-year low of -0.09% on Wednesday, the lowest level yet seen in this cycle and the lowest level since the global financial crisis in 2007. There has been widespread talk in the markets this week about whether that partial inversion of the yield curve it is a harbinger of a recession.
China saber-rattles with threat to cut-off of rare-earth exports to U.S. — China is clearly preparing to cut off, or at least slow, the export of rare earth minerals to the U.S. as a retaliatory move if the US/China trade and tech war worsens. The editor-in-chief of the Global Times, a newspaper affiliated with the Communist Party, said on Wednesday that China is “seriously” considering restricting the export to the U.S. of rare earth minerals.
China supplies about 80% of U.S. imports of rare earth minerals, which are used in a variety of industries including electronics, energy, defense, and automobiles. A cut-off of access by U.S. companies to those rare earth minerals could severely crimp the availability of a wide range of key products including magnets, petroleum refining products, polishing powder, batteries, metallurgy, automotive catalysts, glass additives, and luminescent materials.
China at a minimum is saber-rattling on rare earths ahead of a decision by President Trump on whether he will go ahead with his threat to slap a 25% tariff on another $300 billion of Chinese goods. President Trump said in mid-May that action could come in a month, which would imply an announcement date of mid-June. The U.S. Trade Representative’s office has filed the necessary paperwork for that tariff hike and a public hearing is scheduled for June 17. However, Mr. Trump may delay his decision until after he hears what Chinese President Xi has to say at their expected meeting at the G-20 summit in Japan on June 28-29.
China is likely holding its rare-earth threat in abeyance for the time being so that it has a big cannon available for retaliation if Mr. Trump goes ahead with the 25% tariff on another $300 billion of Chinese goods. Chinese media has now given U.S. companies fair warning that they could soon be cut off from China’s rare-earth metals if they don’t put enough pressure on the White House to prevent another round of trade blows. It remains to be seen whether President Trump would go ahead with the 25% tariff on another $300 billion of Chinese goods even if he knows there is going to be a shutdown of rare-earth imports.
China’s manufacturing PMI is expected to slip back below 50 — The markets will be carefully watching Thursday night’s (ET) Chinese PMI reports to assess the extent to which the Chinese economy is slipping in response to the US/Chinese trade war. China’s manufacturing PMI fell below 50 in the 3-month period of Dec-Feb but was then able to rise back above the boom-bust level of 50 to 50.5 in March. However, the manufacturing PMI then fell by -0.4 points to 50.1 in April and tonight’s report for May is expected to show a slip by another -0.2 points to 49.9. In some better news, the manufacturing new orders index in April of 51.4 was a little stronger than the headline index of 50.1. However, China’s new export order sub-index has been below 50 for the last eleven straight months and remained weak at 49.2 in April.
Meanwhile, the Chinese non-manufacturing PMI is in better shape, having reached a 6-month high of 54.8 in March before fading by -0.5 points to 54.3 in April. Today’s report for May is expected to be unchanged at 54.3, remaining comfortably above the boom-bust level of 50.0.
U.S. economic reports expected to be mixed — On the positive side, today’s April U.S. pending home sales report is expected to show a +0.5 point increase, adding to March’s +3.8% increase. The U.S. housing sector has received a boost from the sharp drop in mortgage rates seen since late 2018. On the negative side, however, today’s initial unemployment claims report is expected to show a small increase of +4,000. Also, today’s Q1 GDP report is expected to be revised lower to +3.0% from +3.2%. The Q1 GDP is likely to mark the high-water mark for U.S. economic growth from some time to come. The consensus is for U.S. GDP to ease to +2.0% in Q2 and average +2.1% in the second half of the year. GDP is then expected to ease to +1.9% in 2020-21.
