Weekly Market Update: Global Worries Test Market Résolve
Sentiment took a turn for the worse this week as the third quarter of 2015 drew to a close. Continued worries about commodity market fallout sent mining and trading conglomerate Glencore into a tailspin on Monday, getting the week off to a shaky start. Inauspicious August and September economic data did not improve the outlook: the US September payrolls report missed expectations, Chinese industrial profits fell the most in four years in August while official and private September manufacturing PMIs (49.8 and 47.2, respectively) remained in contraction. German September CPI flat-lined and August retail sales contracted. Early in the week equities indices tested the August 'flash crash' low, but buyers returned on Friday, shaking off the jobs report. The S&P500 ended the week up 1%. Funds flowed into government bonds, with the 10-year benchmark UST yield dropping below 2% for the first time since August. The IMF foreshadowed a downgrade to global growth (its annual outlook is published next week), calling its 3.3% 2015 GDP objective set in July as no longer realistic, while the Atlanta Fed cut its US Q3 GDP tracking forecast to +0.9% from +1.8% prior.
US stock averages saw their worst quarterly performance since the third quarter of 2011, when the European debt crisis crushed financial markets. For the third quarter, the S&P 500 fell 6.9%, the DJIA dropped 7.6% and the Nasdaq declined 7.4%. Japan's Nikkei average fell 14%, its worst quarter since 2010, while the Shanghai Composite (-28%) and Bovespa (-15%) posted their worst declines since 2008. The VIX volatility index on August 24th jumped to its highest closing level since October 2011 and has remained above its long-term average of 20 since then, signaling continued demand for options to protect against stock swings. Money has flowed into lower-risk assets: the yield on the 10-year benchmark UST declined from 2.42% to around 2.02% in the quarter.
Investors dumped junk bonds again this week, driving the worst sell-off for high-yield debt since October 2011, according to an S&P Capital IQ index of high-yield debt. The average yield of high-yield debt tracked by the index, comprised of large junk-rated companies, jumped to 8.62% on Monday after surging above 8% last week. Almost all of the components of the index were in the red. A Dealogic report noted that while YTD corporate debt issuance in the US soared 11% y/y to $1.03 trillion, junk bond issuance has fallen 16% YTD to $224 billion amid the ongoing commodity crackup.
The disappointing US jobs report on Friday derailed any chances for an October Fed rate liftoff. Nonfarm payrolls rose just 142K in September, missing expectations by about 60K, and the prior two months payrolls were revised down a combined 59K. The August-September average of 139K represents a significant deceleration from the 214K average in the first seven months of the year. Average hourly earnings stalled out, dropping to unchanged m/m from +0.4% in August, and there was a surprise one-tenth drop in hourly earnings as well. There were hints that demographic factors had something to do with the weak number: the labor force participation rate fell again, to 62.4% from 62.6% prior, the lowest rate since 1977, along with another incremental decline in the overall labor force size. Just yesterday, the continuing jobless claims data from the week ending September 26th fell to 2.19 million, the lowest level since November 2000, while the September unemployment rate in percentage terms just missed rounding down to 5.0%. Both suggest the job market is hardly struggling.
One payrolls report may have undone a bumper crop's worth of Fed speak. Dudley, Lacker, Rosengren and Willams all said the FOMC would most likely raise rates this year, reiterating familiar talking points about October being a live meeting, the US economy making progress despite global uncertainty, and economic data looking better. Then the September payrolls data arrived, making doves Evans and Kocherlakota look more prescient, given their critiques that lagging inflation could arrest job growth. This week Evans said that while there has been considerable progress made on the employment mandate, raising rates too early undermines the inflation target credibility. Kocherlakota said the Fed should not choke off job creation in the absence of inflation. Note that in data out this week, the August annualized core PCE (the FOMC's primary gauge of inflation) was stuck at +1.3%, well short of the 2% inflation target. As of Friday, Fed fund futures were pricing in almost no chance of a rate hike this month, and a roughly 30% probability by December.
Crude prices were stuck within recent ranges this week, showing only muted reactions to developments in Syria, big inventory builds and the weaker dollar. WTI crude pivoted in a very narrow range around $45 despite the big, unexpected builds in the weekly API and DoE petroleum inventory reports. The two reports registered their first gain in crude inventories in three weeks. Russian forces have begun bombing targets in Syria, claiming they are attacking ISIS even as Syrian opposition sources say the Russian attacks hit moderate rebel forces.
Worries that a meltdown in Glencore could trigger a broader market collapse were the focal point on Monday. London-traded shares of the mining giant stock fell another 30% on Monday after analysts at Investec wrote that persistent, weak commodity prices could wipe out all of the company's equity value. That followed last week's 25% slide after Goldman said the firm could lose its investment-grade rating. Analysts began talking about Glencore having a Lehman moment, given its trading desk's high leverage ratio and huge network of counterparties. Management scheduled a series of meetings with major investors to calm nerves and declared the company was operationally and financially robust, and had up to $50B in credit lines that were only 30% used. By Friday, shares of Glencore had erased almost all of Monday's losses.
Alcoa became the latest large cap name to announce a plan to split the firm into two separate public companies. The upstream spinoff will include Alcoa's mining, alumina refining and aluminum production assets, while the downstream spinoff will aggregate its aluminum product manufacturing assets. The tax-free transaction is expected to be completed in the second half of 2016. Alcoa has struggled amid chronic oversupply in the aluminum markets. The price of the metal has fallen 16% this year as consumption in China slows while producers there try to export more metal.
Japanese Prime Minister Shinzo Abe began discussing a new stage of his economic overhaul, dubbed "Abenomics 2.0." Abe vowed to continue aggressive monetary easing and boost fiscal spending, promising to do whatever necessary to put Japan's economy on robust growth path. Abe claimed the deflation mindset that plagued Japan for so long has been thrown off (despite the negative reading in the August national CPI data). USD/JPY bottomed out after two days of declines around 119.25, then rose after slightly better Japan business confidence and Abe's speech, to hit 120.40 on Friday. The US jobs report saw the pair briefly drop as low as 118.70.
The Reserve Bank of India (RBI) cut its repo rate for the fourth time in 2015 at its scheduled meeting today, cutting more than expected, to a 4.5-year low of 6.75% from 7.25% prior. The RBI has been under pressure to boost growth after inflation hit a record low of 3.6% in August due to falling commodity prices. "In India, a tentative economic recovery is underway, but is still far from robust," said RBI governor Rajan. USD/INR has sunk to fresh six-week lows after the move, around 65.5.