Monday Musings: January 13, 2020

Jan 13, 2020

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Public Trust Credit Team
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Will we finally sign a deal?

The U.S. and China are finally set to sign the “phase one” trade deal this Wednesday, January 15. The key terms of the deal are for China to agree increasing agricultural imports from the U.S. to $50 billion a year and to increase general products and services imports by $200 billion over two years; in exchange, the U.S. would still not implement the proposed December 15, 2019, “phase 4b” tariffs and would roll back the September list 4 tariffs by half. Another more symbolic gesture of the trade deal is China’s agreement to not manipulate its currency, prompting the U.S. to remove China from its list of currency manipulators earlier today. The terms of the agreement appear challenging as they translate to a 100% increase in agricultural exports to China and a 64% annual increase in goods and services exports over 2018 levels. Still, all signs point to a signing on Wednesday, potentially providing a much anticipated de-escalation for the markets. 
 
Last week, the latest ISM non-manufacturing PMI reading (which examines the services sector of the economy) and the December payrolls were released. The ISM index came in strong with its 119 consecutive month of growth and showed strength across measures. The general expectation is that the “phase-one” deal will show upside for the non-manufacturing index through 2020. However, payrolls were soft, missing the 160k consensus estimate while seeing downward revisions to the October and Novembers numbers as well. While wages and payrolls were soft, the unemployment rate held steady at 3.5% and the U-6 unemployment rate, which also measures discouraged and part-time workers, fell to 6.7%, the lowest level since 1994. Overall, the payroll signals can be viewed as neutral moving into 2020.

President of the Federal Reserve Bank of Boston expects a healthy U.S. economy over the next year but believes inflation may pose a greater risk than trade in 2020

The Boston Fed’s President, Eric Rosengren, spoke this morning regarding his outlook for the U.S. economy and monetary policy in 2020. Mr. Rosengren’s overarching theme during his presentation was that Fed policymakers anticipate an “almost ideal” economic outcome including inflation rising to the Fed’s 2% target; a strong labor market; and 2020 economic growth near his 1.75% estimate of potential growth. Interestingly, the Boston Fed President noted that downside pressures to the economy from above-target inflation and financial assets may pose a greater risk than trade disputes and stubborn global growth. The current accommodative monetary policy and tight labor markets may help fuel greater-than-expected inflation. Indeed, stronger wage growth may result in increased price pressures as corporations look for ways to offset higher labor costs. However, Mr. Rosengren concluded his remarks by stating that forecasters and Fed policymakers “anticipate a good outcome for the economy in 2020 and beyond.”

Empirical evidence of the market's appetite for high-grade issuance belies expectations and neutral sentiment

High-grade bond issuance in the first full week of 2020 was $66.1B (per Wells Fargo), representing the third-largest issuance volume in the history of the investment-grade market. Admittedly, this is only one data point, but the historically large volume may contradict a recent Bank of America Securities (BofA) survey result showing that 68% of credit market respondents expect declining annual issuance volumes in 2020. That view is directionally in-line with some of the recent investment bank research team estimates. Alternatively, the large volume may imply that the issuance calendar will be front-end loaded and that issuers’ already elevated leverage will reach its limit in the first half of the year. In light of the spate of 2020 outlook revision updates scheduled for the coming weeks, the market’s positive reception of additional issuance may drive issuance estimates higher for the coming year. In order to hold that view for the high-grade sector, cash flow generation would also need to rise (due to the ratings’ agencies focus on Debt/EBITDA). In short, it looks like the market is telling the prognosticators that opportunities are stronger than they appeared just a few weeks ago.
All comments and discussion presented are purely based on opinion and assumptions, not fact. These assumptions may or may not be correct based on foreseen and unforeseen events. The information presented should not be used in making any investment decisions. This material is not a recommendation to buy, sell, implement, or change any securities or investment strategy, function, or process. Any financial and/or investment decision should be made only after considerable research, consideration, and involvement with an experienced professional engaged for the specific purpose. Past performance is not an indication of future performance. Any financial and/or investment decision may incur losses.

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