Budget Deficit Grow, Stocks, Bond Yields Fall, Negative Interest Rates Spread!
Global stocks and bond yields slid Friday as weak manufacturing data deepened investors’ anxiety about the health of the world economy. Budget Deficit Grow, Stocks, Bond Yields Fall, Negative Interest Rates Spread!
Yield on 10-year U.S. Treasury note slid to fresh low for the year.
Major stock indexes have managed to rally this year despite a slowdown in the global economy, in part because central banks have signaled they will back off plans to normalize monetary policy for the foreseeable future.
But signs that momentum continues to cool across major economies have challenged investors, raising questions about whether a soft patch of data could mark the start of a more persistent downturn.
A report Friday showed factory output in the eurozone fell in March at the fastest pace in six years, while a gauge of U.S. manufacturing activity slipped to its lowest level in nearly two years. The data sent bond yields tumbling, with the German 10-year bond yield trading in negative territory for the first time since 2016 and the yield on the 10-year U.S. Treasury note at 2.453%, a fresh low for the year.
Meanwhile, stocks across the world retreated, with the S&P 500 losing 1.7% and benchmark indexes in France, the U.K. and Germany ending down more than 1% apiece.
“The global economy has clearly become an issue, with big headwinds there,” said Tim Anderson, managing director at broker-dealer TJM Investments, pointing to mounting worries particularly in Europe and China.
For much of 2019, stocks and bond yields had moved in opposite directions. That troubled fund managers, who noted bond yields typically rise—not fall—when investors are confident in future prospects for growth.
But they moved lower in lockstep Friday, as investors across markets bet on an environment in which growth across the world is expected to slow.
“This confirms the softening data tone the market has been observing and central banks have been forced to take note of,” said Matt Cairns, strategist at Rabobank.
Bank stocks slid again Friday, putting the KBW Nasdaq Bank Index of large lenders on track for its biggest one-week slide since December. The group has been hit particularly hard by recent stock declines, in part because lower interest rates and slowing growth bode poorly for lending profitability.
“The market is polarized: Half thinks we are in a bull-market recovery and the other half thinks we are in a bear-market rally” —Eoin Murray, head of investment at asset manager Hermes
Bank of America shed 4.5%, while Morgan Stanley declined 3.6% and Goldman Sachs fell 2.5%.
Commodities prices and stock sectors tied to them retreated, underscoring the dimming outlook for the global economy.
The S&P 500 energy and materials sectors lost nearly 3% apiece, while copper futures-—which tend to rise when investors expect growth to boost consumption of industrial materials-—retreated to a one-month low.
Part of investors’ anxiety, many say, stems from doubts about whether central banks’ wait-and-see approach to monetary policy will be enough to avert a global economic slowdown.
Earlier this week, Federal Reserve officials indicated they are unlikely to raise interest rates this year and may be nearly finished with the series of increases they began more than three years ago. On Wednesday, Fed Chairman Jerome Powell suggested the central bank was likely to leave the policy rate unchanged for many months.
This change of tactic by the Fed has divided the market. For some, it is the latest sign that economic growth in the U.S. and around the world is slowing. For others, a more dovish Fed could prolong the bull market.
“The market is polarized: Half thinks we are in a bull market recovery and the other half thinks we are in a bear market rally,” said Eoin Murray, head of investment at asset manager Hermes.
To be sure, many believe that in the U.S., a recession isn’t imminent.
Corporate earnings, while cooling, are still expected to post single-digit percentage growth in 2019, according to FactSet. The labor market has added jobs for 101 consecutive months, its longest streak ever, and unemployment remains low.
Even weaker segments of the economy have appeared to stabilize in recent months, with data Friday showing sales of previously owned homes soared 12% in February—far more than economists had expected.
But the question investors say they are contending with is whether the slowdown in the eurozone could have a ripple effect, hitting profits at multinationals in the U.S.
In one warning sign, a closely watched yield curve inverted Friday for the first time since 2007.
The spread between 3-month and 10-year U.S. Treasurys fell to -0.03 percentage point. Investors and Fed officials closely watch the dispersion of short- and longer-term yields because the three-month yield has exceeded the 10-year yield ahead of every recession since 1975.
In another sign of pessimism, traders doubled down on bets that the Fed will go as far as lowering rates soon—something they haven’t done since the midst of the financial crisis in 2008.
Federal-funds futures, used by traders to place bets on the course of monetary, showed the market pricing in a more than 60% chance of the Fed lowering rates by the end of the year, according to CME Group. That marked the highest probability yet this year.
Twin Troubles Strike The Bond Market
Negative yields on German bunds and an unusual dynamic in the Treasury market are adding to investor nervousness.
The global bond market flashed two prominent warning signals on the economy Friday, spooking investors and feeding a selloff in stocks—particularly bank stocks.
The yield on 10-year German government bonds, the European benchmark, turned negative for the first time since 2016. Across the Atlantic, the 10-year Treasury yield fell below that of three-month Treasury bills. This “inversion,” which was last seen in August 2007, is considered to be a reliable predictor of recessions in the U.S.
The two signs emerged against the backdrop of cascading bond yields world-wide spurred in part by weak readings from the eurozone manufacturing sector. Disappointing data from purchasing-managers indexes, especially in Germany and France, exacerbated worries about the health of the region’s economy and possible knock-on effects in the U.S.
“You have a very clear signal here that the market is anticipating a notable slowdown on both sides of the Atlantic,” said Richard McGuire, head of rates strategy at Dutch group Rabobank.
Recent warnings from central banks about the state of developed economies have increased investor demand for safe government bonds, which pushes up prices and drives down yields. Stock markets declined, with banks hit hard. Citigroup slid nearly 5%, Italy’s largest lender UniCredit fell 4.5% and Société Générale of France was down nearly 4%.
The yield on 10-year German debt, called bunds, touched -0.03% on Friday, the lowest level since October 2016. Germany’s export-driven economy is Europe’s powerhouse, but it is vulnerable to the global growth outlook. Germany relies on China, but growth there is slowing, too, in part due to trade tensions with the U.S.
“The margin between stabilization and full-blown recession in Europe is becoming more and more thin,” said Maurice Harari, senior portfolio manager at SYZ Asset Management.
Downbeat growth predictions have prompted central banks in the U.S. and Europe to step back from their plans to reintroduce more-normal monetary policy—with higher interest rates and less quantitative easing.
The fall in European yields has put pressure on U.S. yields, as investors starved of returns in Europe are moving into Treasurys. Investors’ other option is to take more credit risk by buying lower-quality debt or longer-term bonds.
Investors are left confronted with a conundrum, according to James Athey, senior investment manager at Aberdeen Standard Investments: Either accept a definite small loss from a negative yield, or take risks that could lead to bigger losses.
“People say it’s a tax on banks, but it’s a tax on companies, it’s a tax on individuals, it’s a tax on the entire system because nobody can get a return on their investments without taking risk,” Mr. Athey said of negative yields.
Bunds’ slide has accelerated in recent weeks. The European Central Bank rattled markets this month by slashing forecasts for real economic growth this year to 1.1% from 1.7% predicted three months ago. ECB President Mario Draghi added that the central bank’s benchmark rates, currently negative, would be held steady through 2019 rather than just through the summer.
Banks and insurers are on the front lines of dealing with subzero rates. Negative yields are destructive for profits at banks and insurers and painful for savers. European bank stocks lost a third of their value in the first half of 2016, when the 10-year bund yield first went negative, and have suffered again in recent days.
The Stoxx Europe 600 Banks index has shed nearly 5% this week.
European banks themselves are part of the problem, said Alberto Gallo, portfolio manager at Algebris Investments. They have been slow to clear their balance sheets of problem loans and so are unable to help the economy grow, Mr. Gallo said.
European companies, unlike those in the U.S., rely more heavily on bank lending than on the bond market.
“Bond markets allow you to recover from a balance-sheet recession more quickly because everything gets priced in immediately and is restructured in a few quarters,” Mr. Gallo said.
“But with bank loans you get extend and pretend,” he said, referring to banks rolling over loans to problem borrowers rather than writing them off or seizing borrowers’ assets. “In Europe, you end up still with hundreds of billions of bad loans on bank balance sheets more than 10 years after the crisis and that restricts growth.”
U.S. Budget Deficit Grew 39% in First Five Months of Fiscal 2019
Tax revenues little changed so far in fiscal 2019.
The U.S. budget gap widened 39% in the first five months of the fiscal year as tax revenues held steady and federal spending increased.
The government ran a $544 billion deficit from October through February, the Treasury Department said Friday, compared with $391 billion during the same period a year earlier. Federal outlays rose 9%, to $1.8 trillion, while revenues declined less than 1%, to $1.28 trillion.
Part of the increase in the deficit was attributable to a shift in the timing of certain payments, which made the deficit appear larger. If not for those timing shifts, the deficit would have risen 25% from the same period in fiscal year 2018.
Higher spending on health care, the military and tariff-assistance programs for farmers pushed the deficit to a record $234 billion in February, 9% higher than the same period a year earlier, as federal spending outpace tax collections.
The government typically runs a deficit in the month of February, as the Treasury begins to send out tax refunds to individuals, and businesses aren’t due to make any scheduled tax payments.
Last month, federal tax receipts rose 7%, due in part to a 5% increase in individual income-tax collection compared with February 2018. The rise is significant, a senior Treasury official said, because employers were withholding income from individual taxpayers at a higher rate for part of February 2018, before the Tax Cuts and Job Act took effect midmonth.
The tax code overhaul enacted in 2017 had constrained federal revenues over the past year. Going forward, Treasury expects revenue collection to stabilize or increase as rising wages boost workers’ paychecks.
Another source of rising revenues last month was tariff collections, which rose $3 billion, a 93% increase from February 2018. That was partially offset by higher spending by the Agriculture Department, which a senior Treasury official attributed to assistance programs for farmers facing retaliatory tariffs.
On a 12-month basis, revenues declined 0.7% and outlays rose 5%. For the 12 months ended February, the deficit totaled $932.2 billion, or 4.5% as a share of gross domestic product, the highest since May 2013.
Low Yields Might Mean This Is as Good as It Gets
A realization is growing that a stubborn shift lower is the new way of the world.
In October, investors were worried that higher bond yields would hurt stocks. In January—after the Federal Reserve backtracked on rate rises—they thought lower yields would help stocks. Now, falling government-bond yields world-wide are spooking shareholders, with some on Wall Street again talking about recession.
What’s going on? We saw something similar in 2016; then as now, the concerns were in large part made in China. But look deeper, and there is something else afoot: A rising sense not of imminent trouble but of a realization that central banks might not be able to spark growth and inflation, and that a stubborn shift lower is the new way of the world.
In 2016, bond markets freaked out and yields reached record lows. This week, the German 10-year bond, the benchmark for the eurozone, came within a hair’s breadth of that 2016 trough. In the U.S., the level of yield is much higher, but the scale of the fall since October is virtually identical to the fall to the lows over the same time frame in 2015-2016.
There are other similarities. Investors are worrying that future inflation will be subdued. In the U.S., the probability of inflation above 3% over the next five years has fallen below 7% for the first time, aside from the recession panic of December, since 2016, according to the Minneapolis Federal Reserve.
In both the U.S. and Europe, future inflation expectations priced into markets have fallen, in Europe’s case a lot. The eurozone inflation swap for the five years starting in five years’ time, a gauge closely watched by the European Central Bank, is back below 1.3% and close to the 2016 low.
Traders are betting that the Fed will cut rates more than once by January. Meanwhile, the ECB isn’t expected to push rates back above zero for seven years, twice as long as was expected at the start of the year.
In 2016, investors feared that China’s economy was slowing, and there was a hangover from the previous year’s devaluation of the yuan. Today the danger is that the trade fight with China badly hurts global manufacturing, already struggling with a tepid world economy.
In some ways, a repeat of 2016 might be welcome. The rapid decline in bond yields in the summer of 2016 was ignored by equities, which were on the rebound from the oil slump at the start of that year. Bond yields snapped back up again fast, then soared when Donald Trump was elected president.
Yet, there are significant differences. The 2016 low in yields came amid serious concerns about Britain’s vote to leave the European Union. It didn’t take long for investors to conclude that this was a problem mainly for the British, as it has stayed since then.
“It feels more like a slow burn this time as opposed to the shock of the Brexit event,” says Andrew Bosomworth, Pimco’s head of portfolio management in Germany. “Trade has been more of a drip-feed process.”
Inflation was a more obvious problem in 2016, too. The big drop in oil prices had left Europe and Japan with headline deflation once again, encouraging talk of a deflationary spiral. Inflation options implied a 40% chance of price rises averaging less than 1% over five years.
This time, there is much less concern about deflation. Options markets suggest only a 12% chance of such “lowflation” on the way, and current headline inflation isn’t far below central banks’ 2% target in the U.S. and Europe; Japan is still failing to reach its goal, but at 0.9% in April was some way from deflation.
Instead, the concern this time is that the economic models central banks and investors rely on to forecast inflation no longer work. Perhaps the internet, trade and manufacturing technology will cap price rises even with full employment?
“It’s this growing sense that there might be little mini [economic] cycles but the long-term outlook is a rather depressing grind lower in potential growth and inflation prospects,” says Sebastian Mackay, a multi-asset fund manager at Invesco. “It just seems that central banks’ direct influence on inflation is quite limited.”
This view is one reason stocks and corporate bonds have fallen much less than the drop in bond yields might suggest. Sure, the S&P 500 is down 5.5% from its peak. And corporate-bond yields are up, although nowhere near as much as in 2016. But the general rush for safety that took place in 2016 hasn’t been repeated this year in classic havens such as gold and the yen.
Investors who fear specific events—higher tariffs, Brexit—can quickly change their minds if the events don’t pan out as expected. It takes a lot longer to shift entrenched views about what counts as normal for inflation or for the power of central banks, or a long-running confrontation with China. The danger is that unlike in 2016, this time around low yields are caused as much by a shift in mind-set as they are by the impact of trade barriers on the economy.
U.S. Budget Gap Widens 27% in First 10 Months of Fiscal Year
The government collected $2.9 trillion in receipts, a 3% increase, while spending climbed 8% so far this fiscal year.
The U.S. budget gap widened further in July as federal spending outpaced revenue collection, bringing the deficit to $867 billion so far this fiscal year, a 27% increase from the same period a year earlier.
The Treasury Department said Monday federal receipts rose 3% from October through July, totaling $2.9 trillion, while outlays climbed 8%, to $3.7 trillion. A senior Treasury official said federal revenue collection has picked up significantly since April compared with a year earlier, when lower tax rates implemented under the 2017 tax overhaul weighed on receipts.
At the same time, rising enrollment in Medicare and higher interest rates have led to higher government costs on benefits and interest payments, pushing the deficit even higher despite robust economic growth that usually shrinks budget shortfalls.
Part of the increase in the deficit so far this fiscal year, which began Oct. 1, can be attributed to calendar quirks, which made the gap appear slightly larger. If not for a shift in the timing of certain payments, the deficit would have been 20% higher during the first 10 months of the fiscal year, the Treasury said.
Higher deficits have forced the government to ramp up borrowing since early 2018, due in part to slumping revenue following the tax cut and a 2018 budget deal that lifted domestic and military spending for two years.
Over the 12 months that ended in July, the deficit totaled $961.8 billion, or 4.5% as a share of gross domestic product. Revenues over the previous 12 months rose 2.4%, while federal spending was up 6.3%.
Much of the increase in revenue collection so far this fiscal year has occurred in the past few months, the senior Treasury official said, thanks in part to a sturdy economy that has boosted tax receipts. Net individual taxes are up 7% since April, or $42 billion, and net corporate taxes have grown 30% since then, the official said.
Revenue from tariffs, or customs duties, also increased 75% through July, a significant boost from the same period a year earlier but just 2% of total receipts collected during that time.
The Treasury said last month it expects to borrow more than $1 trillion this calendar year for the second year in a row, as the annual budget gap is on track to exceed $1 trillion for fiscal year 2019, which ends Sept. 30.
A recently enacted budget deal, which President Trump signed earlier this month, will maintain the current government spending trajectory and add further to federal deficits over the next two years.
More broadly, deficits are projected to continue rising over the coming decades as a wave of retiring baby boomers pushes up government outlays on Social Security and Medicare.
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