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November 2019 Fixed Income Market Update

Economic and market perspective

Declining geopolitical risk in the form of tempering of tensions regarding China trade and Brexit as well as easing monetary policy in the U.S. improved market sentiment in the month. Global manufacturing data weakened, while U.S. employment data remained solid.

Following the October 10-11 meeting in Washington the U.S. and China announced a “Phase 1” or “mini deal” to address the long-standing tariff standoff. The U.S. agreed to delay implementation of additional tariffs and postpone increases in existing tariffs.  China agreed to purchase additional U.S. agricultural products, increase protections on intellectual property and issue guidelines on currency management.  At the end of October, President Trump referred to the deal as 60% of the final deal and indicating that the location of the deal signing would be announced soon.

Eurozone manufacturing PMI rose to 46.2, still showing contraction, and the composite PMI was only slightly expansionary at 50.2. German manufacturing PMI rose to 41.7, up 0.2% from last month, but still meaningfully below the 50 level dividing between expansion and contraction. Chinese official manufacturers PMI of 49.3 in October reflected the sixth consecutive month of contraction. 

British Parliament appeared to make progress regarding Brexit, passing a proposal to exit the E.U., however, the vote regarding the timing did not pass. As a result, the U.K. requested and received an extension of the deadline for exit from the E.U. until January 31, 2020.  After a back and forth regarding calling early elections, it was finally agreed to hold a general election on December 12; the expectation is that the results of the election will impact the final terms of Brexit

To date, third quarter corporate earnings have declined 3.7% versus the 2018 earnings according to FactSet. If this trend holds, it would be the worst year-over-year decline since the first quarter of 2016 (-6.9%) and the first time period with three consecutive quarters of year-over-year earnings declines since the beginning of 2016. Nonetheless, in the current reporting period, 80% of companies reporting to date have beat expectations.   A rebound in earnings (+3.0%) is expected for the fourth quarter that would bring full year earnings growth to 0.6%.  That rebound is expected to carry into the first  quarter (+4.7%) and second quarter of 2020 (+7.3%) with full year 2020 earnings growth projected at 9.9%.

Outlook and conclusions

The Federal Open Market Committee cut the Fed Funds rate by 25 basis points at its October 29-30th meeting, in line with market expectations. The 25 basis point cut brought the range for the Fed Funds Rate  to 1.50% – 1.75%.  This was the third consecutive Fed meeting where the Fed delivered a rate cut. Two members of the committee dissented in favor of leaving rates unchanged. The Fed statement was notable for removing the language that it would “act as appropriate to sustain the expansion.” This shift in wording has been interpreted as the Fed suggesting a pause in rate cuts.  This interpretation was supported by Chairman Powell’s news conference wherein he said that committee members “see the current stance of monetary policy as likely to remain appropriate.” As of the end of October, the market is pricing in approximately a 30% probability of an additional rate cut at the Fed’s December 10-11th meeting and a better than 50% at the January 28-29th meeting.

On October 11th, the Fed announced it would begin buying $60 billion a month of Treasury bills starting mid-October and extending at least until the second quarter of 2020.  The Fed stated that “these actions are purely technical measures” to support liquidity and stabilize overnight rates and “do not represent a change” in policy (i.e. not reinitiating quantitative easing.)  The Fed’s balance sheet increased by about $100 billion in October; even with newer purchases focusing on Treasury bills, longer maturity Treasuries and agency mortgage backed securities still comprise 90% of the balance sheet.

In our view, the decline in global manufacturing data is noteworthy, while the arc of U.S. data remains reasonable.  Though some recent data suggests a softening of consumer strength, the U.S. consumer remains in good position to carry the U.S. and possibly the global economy forward. Though corporate profits have weakened, the year-over-year comparison is difficult given the strength of 2018 profits.  All in all, we find talk of recession premature, though continued weakening of data is a reasonable baseline.  We remain cautious regarding expectations on the trade and Brexit front given the already prolonged and complex nature of the issues, though progress in October was certainly welcome.  The continued monetary easing from the Fed is delivering the intended confidence and liquidity to markets. While neither rates nor spreads appear cheap, the combination of reasonable fundamentals, monetary policy support and global demand continue to support U.S. fixed income.

Originally Posted on November 1, 2019 – November 2019 Fixed Income Market Update

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