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Watching Fed’s Move as US Economic Data Turns

Recent released economic data has given us a taste about the year ahead of us. In this article, we will review the important ones related to the US job market and GDP, and then comment on the possible reactions that the Federal Reserve will take to avoid causing stock market turmoil or economic recession.

Robust Labour Market Extend to 2019

In 2018, the U.S. has added around 223,000 new jobs per month in average. The trend of strong payroll increase has extended to 2019 as the January number surged to around 304,000. Looking at the unemployment rate, in 2018, the number once dropped to the lowest since 1970 at 3.7%. Even though the unemployment rate seems to raise up a little to 4%, the increase is largely coming from higher labour participation. As shown in below picture, the unemployment rate raised up from 3.7% in September 2018 to 4% in January 2019 while participation rate increased from 62.7% to 63.2% in the same period. We think the rise in participation is a positive sign for labour market as it indicates people who previously not working nor looking for job opportunities are now attracted to the labour market again and thus the increase in unemployment should not cause too much worry.

Unemployment Rate (Blue) and Participation Rate (Green)

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Data Source: Bloomberg, FinEX Asia Research

Further on, we have not only seen positive signs on the supply side, the job openings offered by firms have also been on an upward trend proving strong demand for labour. Therefore, we think the labour market will continue to be tight for a while and the unemployment rate could drop further.

US Job Opening Rate

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Data Source: Bloomberg, FinEX Asia Research

Setback Seen in Economic Data but might be Temporary 

The retail sales released last week has posted a big downward surprise to the market. Though up to revision, the -1.2% decline was the worst retail sales data since 2009 when the economy was still emerging from recession. Data for November was also revised slightly down to show retail sales edging up 0.1 percent instead of gaining 0.2 percent as previously reported.

The drop of retail sales posted a stark contrast to the robust labour market data, especially the rising wages. The cost saving of fuel due to low crude oil price also failed to boost up people’s willingness to spend. This, however, could be caused by the government shutdown and stock market turmoil which both affected people’s confidence on spending. The data shows except autos and building materials, consumers seem to cut on everything else. As government reopened, we expect the retail sales growth will come back to normal but will on the watch out for further  sign, if any.  Nevertheless, this will post pressure on the US GDP in Q4. Previously, we were expecting a near 3% increase, while now it seems reasonable to adjust that down to around 2.5%.

Retail Sales Growth (Blue) Deviate from Wage Growth (Green)

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Data Source: Bloomberg, FinEX Asia Research

Another news on economic data was that industrial production came in weaker than expected. The actual data was -0.6% for January versus the expectations of 0.1%. The decline suggests a cooling at US factories as the trade war impact kicked in indicating economic growth this year might be slower compared to 2018, which would be another indicator to watch.

Expect Extension on March 1 Deadline

Market’s mood on trade war has been changed almost as fast as President Trump tweets. In mid-February, the Asian stock market was still depressed worrying about the trade talk, but it turned to a big rally after positive comments on both sides last week, though nothing substantial mentioned.

Trump’s China-containment strategy and scare tactic did not work too well to US economy. One of Trump’s target is to reduce the trade deficit with China. However, the trade deficit became even larger in 2018.

US Trade Balance with China

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Data Source: Bloomberg, FinEX Asia Research

The disruptions that tariffs imposed on the supply chain of US companies have also adversely affected US companies, which could be seen in the cooling of US manufacturing industry as we mentioned earlier. The uncertainties of US trade policies also increased volatility in the stock market. A further extension of the trade war might not work well for Trump to improve or maintain his approval rate either. Maybe because of above effects, Trump’s tone to China has softened as the impacts to the US deviates from his intentions. On Tuesday, Trump said that trade talks with China are going well and indicate he would be willing to push back the deadline. We think the March 1 deadline will be extended and a partial deal could be achieved some time this year.

Fed Change Tones on Interest Rate Hikes Changed and Balance Sheet Normalization Might Stop

The market is in general in consent that the Fed is going to stop raising interest rates for a while. As the economy of US shows slowing and the negative impact of trade war kicked in, Chairman Powell has modified his tone. Futures markets imply zero interest rate hikes by October, and we think the Fed will on hold at least by June. Another question besides the interest rate hikes is whether the Fed will stop the balance sheet normalization and if so when it will happen.

Balance sheet normalization refers to the Fed’s selling off its huge holding of assets bought a decade ago during QE to brought back the economy from recession. The Fed’s balance sheet once hit a record high of $4.5 trillion by the end of 2014 (before crisis, the balance sheet level was only at $870 billion) and stayed at similar level for three years. Currently, The Fed unfolds from less than $50 billion each month and the bond portfolio has shrunk by more than $400 billion since the normalization started in October 2017. Powell indicated that he would monitor the normalization process but have not mention whether or when the balance sheet roll-off would slow or stop. Federal Reserve likely will bring the balance sheet roll-off to a close by the end of 2019 as reserves get closer to the level where banks feel comfortable, according to minutes released last week.  Undoubtedly. market participants are hoping a early stop or at least a slowdown of normalization pace.

Balance sheet normalization in combination with interest hikes are a double hit to the financial condition which has disturbed investors’ confidence as shown in the recent volatility of stock market. Seems the Fed has already bowed to the market on interest rate. We will be watching on how the Fed would respond to the market’s demand for normalization slowdown.

Fed Unfold Its Balance Sheet

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Data Source: Bloomberg, FinEX Asia Research