Markets took another roller coaster ride last week. The yield on the 10-year U.S. Treasury bond rose to 2.95% – a level it hasn’t seen in four years – but then moved lower by the end of the week.1 Stocks also vacillated, largely in response to those Treasury yield movements. It appears that markets are unsettled and primed to react to the news of the day – both negatively and positively. Below, I discuss five upcoming events that could possibly be the catalyst for more moves ahead.
Here are five things to watch in the coming week:
1) Humphrey-Hawkins testimony. Jerome Powell will make his debut in his new role as Chairperson of the U.S. Federal Reserve (Fed) with his semi-annual Humphrey-Hawkins testimony before Congress. He will speak before the House of Representatives on February 28 and the Senate on March 1. As is customary, the Fed released its Monetary Policy Report in advance of that testimony. While its release was largely overlooked, it is a treasure trove of information, including several special topics that give insight into important concerns for the Fed. Those special topics are:
- Determining how tight the labour market is
- Understanding why inflation has been low in advanced economies
- Closely examining monetary policy rules
These topics will likely be touched on in Powell’s testimony or in the question and answer sessions following his testimony, given markets’ focus on inflation and Fed policy-making. All are very important given they impact Fed decision-making going forward.
2) Brexit negotiations continue. U.K. Prime Minister Theresa May met with her Cabinet last week in an effort to internally agree upon the terms it will seek in Brexit negotiations with the European Union (EU). This was necessary because May is scheduled to meet with European Council President Donald Tusk this week. The prime minister is between a rock and a hard place – she is burdened with unrealistic expectations from much of the U.K. over the terms that she should insist upon for the Brexit, and she is facing general dissatisfaction within the U.K. and even her own party while negotiating against the EU, which clearly has an upper hand. May is reportedly attempting a “cafeteria-type” proposal where the U.K. is advocating for a trade agreement similar to the one it has today on an a la carte basis – without having to assume all of the additional obligations that made membership in the EU unappealing to British citizens.
Negotiations appear headed for trouble as Tusk, not surprisingly, already announced in the past few days that the U.K.’s position is “based on pure illusion” and that the U.K. cannot “have its cake and eat it too.” Tusk made his position abundantly clear last week, explaining, “From the very start, it has been a key principle of the EU-27 that there will be no cherry-picking and no single-market a la carte … This is and will continue to be a key principle, I have no doubt.” We will want to follow negotiations closely, especially given that we’re nearing one year until Brexit is supposed to occur – with far less progress made than should have been made by this time. Lack of progress in negotiations as time rapidly passes suggests economic growth could be further depressed, as economic policy uncertainty typically leads to decreases in corporate spending.
3) China flexing its muscles. Last fall I wrote that Chinese President Xi Jinping was in the process of consolidating power, which could include extending his term in office. This effort has gained significant momentum, as it was announced over the weekend that China plans to drop term limits for the presidency. This is a very significant moment for China, and suggests far greater power for Xi going forward. Last week also saw the Chinese government take over an insurance company and charge its founder with economic crimes. While many pundits believe it demonstrates China’s interest in reining in growing corporate debt, it also is a sign of Xi’s growing power. Greater strength at home will undoubtedly enable Xi to demonstrate greater strength in foreign relations – including trade. Going forward, I expect China to respond in a more powerful way to growing protectionist threats from trading partners such as the U.S.
4) U.S. jobs report. This coming Friday will see the release of the U.S. Employment Situation Report for the month of February. The key data point to focus on is average hourly earnings – in my opinion, this is the single most important metric to be following. Recall that a surprisingly high average hourly earnings number in last month’s jobs report – 2.9% year over year – triggered fears of inflation, higher Treasury yields and, in general, the start of significant market volatility that has yet to end.
5) Italy’s general election. The election will take place next weekend, on March 4. The outcome is uncertain given that there was a moratorium imposed on polling in mid-February, which remains in effect through the election. In addition, when polls were still in effect earlier this month, they showed that about 30% of Italian voters were undecided.2 We will want to pay close attention to this election, given 1) the difficulties Italy may face in forming a governing coalition (think of how long it took for Germany to do the same after its September election) and 2) the possibility that the new government could tilt more anti-EU, which could prove problematic for French President Emmanuel Macron’s attempts at reform and improvement of the EU, including greater fiscal unity (Macron is already having difficulty implementing reforms in his own country).
In summary, after years of relative calm and tranquility in the markets, volatility in equity and bond markets appears to be here to stay. I think of this as a lengthy transition period as markets are normalizing in response to the normalization of monetary policy by central banks.
In essence, last week supplied more evidence of the “Chihuahua market” that I wrote about two weeks ago. Instead of a bull market that drives equities ever higher, we’re seeing a market that can make quite a bit of noise, jump up and down, run in circles and nip at investors’ heels. This market (much like Chihuahuas themselves) is nothing to be scared of, in my view – but some investors may need to adjust their approach in dealing with it. That could include greater diversification, an allocation to alternative investments, and equity strategies that focus on stocks with attractive valuations and a history of low volatility.