Summer is long gone. The mood swing in markets last week was attributed mostly to US trade uncertainty and the FOMC rate hike but underneath all of the soggy price action is a feeling that the storyline driving markets in the summer – “Goldilocks” is transforming into something else.

US divergence continues with the US economy growth, inflation and outlook remaining robust.The EU is different with ECB expectations of tapering high but growth moderation continuing and clearly not breaking out like the US. China is expected to moderate further as trade tariffs kick in and Japan, while doing better with BOJ Kuroda and PM Abe still very much in charge, shows trade issues as well.

Perhaps the biggest shift over the summer was in emerging markets and the hope in 4Q is that there is a return to bargain hunting investment flows supporting growth and currencies there – but the Brazil election, deepening recession in Argentina and Turkey and ongoing pain in South Africa and India suggest this is more than idiosyncratic outflows.

The role of China and trade tariffs is one shift to consider as investors jump into October and 4Q. The view of the summer, that a Mexico deal on trade would lead to a new NAFTA with Canada, better deals in Europe and eventually one with China has stalled. South Korea and hopes for Japan are the exception and the hope over the last week. Nevertheless, the fear of a prolonged trade war is being priced.The view on US an EU politics also changed as hopes for the new Italian coalition playing by the rules on budgets ends and as the US mid-term elections loom.

Hopes for further stimulus spending in the US – infrastructure and more tax cuts – clash with the realities of the growing deficit and expectations of a gridlocked Congress. The market last week did something very different with the USD gaining and stocks losing. This shift matters and might be important if it continues into October and the heavy economic data. The breakout of the USD index over 95 opens 95.70 and risks for 98 again. This may reopen the talk of CNY 7.00 busting, restart 115 JPY and 1.14 EUR. The USD gains run on back of FOMC rate policy, US growth and the view that the US can outlast China in any prolonged trade war.

What Happened over the Weekend?  

The US and Canada are near a NAFTA deal according to Bloomberg. Claims that progress has been made on key issues came from Fox News Saturday with Peter Navarro. Implication for C$ gains into Monday on any announcement are high – with 1.2880 pivotal USD support, then 1.2550.

Also over the weekend another set of horrible weather and natural disasters with Indonesia suffering a tsunami that kills over 800 people after a 7.4 quake. Japan facing another storm and the US Southwest braces for flooding from hurricane Rosa. The US sends a warship through the contested South China sea islands. In politics, Iraqi Kurds hold a parliamentary election today and the German far-right AfD is polling second place. The economic data released early from China given it's a holiday week and it's mixed with Services up and Manufacturing down, the composite index is up but not back to Spring levels.

• China September NBS Manufacturing PMI 50.8.2 from 51.3 – weaker than 51.2 expected – weakest since February. The production index dropped to 53 from 53.3 in August. New orders index decelerated 0.2 to 52, while new export orders slowed by 1.4 points to 48. Services 54.9 from 54.2 – better than 54.8 expected - supported by rising needs of property construction services, a rebound in the financial sector, and active growth of retail, restaurant and postal services. The faster services PMI growth underlines how the Chinese government's campaign to increase consumption to offset the impacts of the China-U.S. trade spat is taking effect. The government has vowed to further cut taxes and related fees for China companies involved in trading with other countries, which could also play a role in the faster services PMI growth.

• China September Caixin Manufacturing PMI 50 from 50.6 – weaker than 50.5 expected. Chinese manufacturers signaled stagnant operating conditions at the end of the third quarter, following improvements in the prior 15 months. Production growth eased to a marginal pace, while total new work was broadly unchanged from the previous month. New export business fell at the quickest rate since early 2016. At the same time, companies continued to reduce their headcounts, while subdued demand conditions led to more cautious approaches to inventories and buying activity. Looking ahead, firms expressed the weakest level of optimism towards the 12-month business outlook in 2018 so far. Concerns continued to mount about the ongoing global trade frictions as well as the near-term impact of strict environmental policies. 

Question for the Week Ahead: What if the FOMC is closer to tightening policy?  

The debate on rates mattering in the US continues to matter but the focus last week was more on trade policy, politics and the rest of the world. Next week, the US data on jobs and ISM will set the tone for how 3Q sets up 4Q for continued growth. The outlook for US growth in 4Q is likely to be shifting higher and with it rate hike expectations – as the market prices in just 1 hike but the FOMC has 3 in 2019.

The other consideration for Fed watchers is that subtle but important shift that NY Fed Williams highlight Friday – the ditching of forward guidance.This means the “gradualism” of policy maybe more about data reactions putting higher uncertainty into markets and leaving the burden of the economy to drive policy reactions.This makes the forecasting game about 4Q that much more interesting.

The 3Q forecasts have clearly been too low to the data so far – putting the US jobs report front and center to shifting up outlooks. Expectations matter in an economy running hot and the confidence boost in both consumers and corporations has held well over the summer. What matters next will be real 3Q earnings for companies and their outlooks for 4Q. The bottom up analysis from FactSet on the street view for owning shares is worth considering in the context of growth and risks for 2019. The market seems convinced that 2020 will be recessionary.

Whether the cycle of stocks and commodities prove out the risk, just like an inverted yield curve or a sharp rise in unemployment, it’s hard to be bearish risk when the FOMC sounds neutral. But just how unimportant rates at 2.25% prove to be to the economy won’t be known until June 2019 and then it maybe a different story.

Market Recap:

Trade tariffs hurt Monday with China skipping talks in Washington, Trump followed with claims China was attempting to interfere in US elections along with a UN address that focused on US first policies. US politics continued to dominate with Deputy AG Rosenstein keeping his job and with SCOTUS Kavanaugh trying to get one. Tesla’s Musk was sued by the SEC and asked to step down as a settlement over the weekend after Friday brought those shares off 12%. The FOMC meeting Tuesday and Wednesday led to a dovish hike as Fed Funds now 2-2.25% with the word “accommodative” removed from the statement suggesting wiggle room for the Fed future path with neutral being a 2-3% band. The market sees a December hike and one more in 2019 while the Fed dot-plot sees 3 in 2019.

In Europe, the focus was on the Italian budget with a 2.4% of GDP budget deficit. This means the EU is on a collision course with the coalition government and that rating agencies are likely to downgrade the debt. As for the data, EU business and consumer confidence levels fell to the worst levels in over a year.

Japan shares rallied with Abe/Trump meetings, Kuroda promising ongoing easy money and slightly better data – though auto sector suffered as trade issues clearly hit. China shares rallied in the second week, ahead of its week-long holiday, with MSCI and FTSE Russell separately announcing that each were taking steps to add more mainland shares to their flagship equity indexes starting next year.

The EM world focused on Argentina pain with the unexpected resignation of Luis Caputo, who only a few months ago became the president of Argentina’s central bank. Caputo’s replacement, Guido Sandleris, who was previously the economic policy secretary, is perceived as being a market-friendly choice. Also the IMF increased its aid package to $57bn. A strike Tuesday crippled most of the nation and the protests against Macri and the IMF are on the rise. India was also a focus with its shares hit on the rising oil prices, the ongoing weak INR and the previous week’s default by Infrastructure Leasing & Financial Services, a nonbank financial lender.

Equities:

The MSCI all-country World Index fell 0.69% to 524.25 on the week, off 0.01% on the month and up 3.77% in 3Q. The MSCI EM index fell 0.33% to 1047.91 on the week, off 0.77% on the month and off 2.06% in 3Q. The biggest winners in 3Q were the US and Japan while the UK, Germany, Hong Kong and China suffered.

Markets are focused on the 3Q earnings reports next with the confessional period being watched for its high warnings. FactSet sees estimated S&P500 earnings at 19.3%, down from 20.4% expected on June 30. A larger percentage of S&P 500 companies have lowered the bar for earnings for Q3 2018 relative to recent quarters. Of the 98 companies that have issued EPS guidance for the third quarter, 74 have issued negative EPS guidance and 24 have issued positive EPS guidance. The percentage of companies issuing negative EPS guidance is 76% (74 out of 98), which is above the 5-year average of 71%.

• The S&P 500 fell 0.54% to 2,913.98 on the week, up 0.43% on the month and 7.20% on the quarter.The DJIA fell 1.07% to 26,458.31 on the week, up 1.9% on the month and 9.01% in 3Q. The NASDAQ rose 0.74% to 8,046.35 on the week, off 0.78% on the month up 7.14% in 3Q. Technology and consumer discretionary outperformed while materials and finance fell. Growth shares beat value. The S&P 500 added a new sector for communications – which replaces the smaller telecommunications sector – and adds many big-name tech and consumer discretionary names like Alphabet, Facebook and Netflix. The Cboe VIX was up 3.77% to 12.12% on the week, down 5.75% on the month and off 24.67% in 3Q.
• The Stoxx Euro 600 fell 0.39% to 380.70 on the week, up 0.13% on the month and up 1.2% in 3Q. The German DAX fell 1.48% to 12,256.73 on the week, off 0.95% on the month and off 0.48% in 3Q. The French CAC40 fell 0.01% to 5,493.49 on the week, up 1.6% on the month and 3.19% in 3Q. The UK FTSE rose 0.27% to 7,510.20 on the week, up 1.05% on the month but down 1.66% in 3Q. The Italian FTSE MIB fell 3.83% to 20,711.70 on the week, up 2.18% on the month and off 4.23% in 3Q.
• The MSCI Asia Pacific Index fell 0.52% to 165.34 on the week, off 0.15% on the month and up 0.8% on the quarter.  Japan Nikkei 225 rose 1.05% to 24,120.04 on the week, up 5.49% on the month and 8.14% on the quarter. The Hong Kong Hang Seng fell 0.59% to 27,788.52 on the week, off 0.35% in September and off 4.03% in 3Q. The China Shanghai Composite rose 0.85% to 2,821.35 on the week, up 3.53% on the month and off 0.92% in 3Q. The Korea Kospi rose 0.17% to 2,356.13 in a holiday shortened week, up 0.87% in September and 0.73% in 3Q. The Australian ASX 200 rose 0.32% to 6,325.50 on the week, off 1.59% on the month and up 0.57% in 3Q. The India Nifty 50 fell 1.91% to 10,930.45 on the week, off 6.42% on the month and up 2.02% in 3Q.

Fixed Income:

The FOMC delivered the 25bps hike as expected. The RBNZ passed as expected and remained dovish enough. The mood on rates was tempered by trade, Italy and equities. Supply in Europe was a factor but most of the tug-and-pulling of prices was on month-end/quarter end factors along with risk-off buying for core bonds. 

• US bonds see choppy curve flattening with focus on jobs next.  2Y up 1.9bps to 2.819%, 3Y off 0.5bps to 2.883%, 5Y up 0.5bps to 2.953%, 10Y off 0.2bps to 3.061%, 30Y up 0.6bps to 3.206%.The range in 3Q for 10Y yields is telling 2.81 to 3.11% a modest range given the Fed hike. 
• Canadian 10-year bond yields flat at 2.423% on the week – Next weeks jobs and trade matter, so too NAFTA talks extending. BOC Poloz hawkish enough.
• Japan JGB yields flat at 0.116% on the week – BOJ surprise in long end buying didn’t last long in steepening curve – focus is on China/US trade, Abe/Trump deals/ growth. Range in 3M was 0.015% to 0.14% with BOJ July policy change hardly a surprise.
• Australian 10-year bond yields fell 3.5bps to 2.665% on the week – focus is on China and trade with RBA expected on hold next week and data mixed.
• UK Gilt yields rose 2bps to 1.571% on the week – Brexit hopes turning to political ugliness and risks for early elections rising.
• German Bund yields rose 1.5bps to 0.468% on the week – all about Italy late in week – with 3M range 0.26-0.56% telling the story. German CPI higher but EU stable – ECB key.
• French OAT yields rose 2.5bps to 0.801% on the week – Macron playing EU stimulus key with equities doing better.
• Italian BTP yields rose 22bps to 3.14% on the week – all about 2.4% of GDP budget deficit and risk of EU pushback, ratings downgrades with 3.25% key.
• Spain Bono yields rose 0.7bps to 1.495% on the week – relative calm but data on growth key next week.
• Portugal 10-year bond yields rose 1bps to 1.87% on the week – holding like Spain but has more risk.
• Greek 10-year bond yields rose 8.5bps to 4.12% on the week – failure to gain much below 4% troubling. Correlation to Italy adding to doubts.

Foreign Exchange:

The US dollar index rose 0.97% on the week to 95.13 – bouncing despite the FOMC removing accommodative and US rates being a sideshow.Italy and politics key with EUR main focus Friday. The technical picture is 94.95 support against 95.50 resistance. 

In Emerging Markets, USD mixed on the week  – EMEA: ZAR up 1.25% to 14.141 on the week but off 2.6% in 3Q, TRY up 3.9% to 6.056 on the week, off 25% in 3Q, RUB up 1.3% to 65.55 on the week, off 4.2% in 3Q.

ASIA: INR off 0.4% to 72.49 on the week, off 5.1% in 3Q, KRW up 0.6% to 1109.30 on the week, up 1.3% in 3Q, TWD up 0.45% to 30.533 on the week, up 0.15% in 3Q, CNY off 0.15% to 6.8690 on the week, off 3.5% in 3Q. 

LATAM: MXN up 0.6% to 18.718 on the week, up 5.3% in 3Q, BRL flat at 4.05 on the week, off 4.6% on the quarter. ARS off 10% to 41.307 on the week, off 32% in 3Q. 

In Crypto Currencies BTC fell 2.2% to $6626 on the week, ETH fell 3.8% to $236 and XRP $0.606 up 4.4% on the week – holding gains from last week – still beating ETH on market cap.

• EUR: 1.1605 off 1.25% on the week, 0.8% on the month, up 0.3% on the quarter. Focus is on ECB and Italy stories developing with 1.1520-1.1820 range holding.
• JPY: 113.70 up 1% on the week, up 2.2% on the month and 2.8% in 3Q. EUR/JPY 131.95 off 0.2% on the week, up 1.4% on the month and 3.1% in 3Q – JPY weakness in 3Q holding and 115 next big level for $ with 112 base.
• GBP: 1.3030 off 0.30% on the week, up 1.2% on the month, off 0.35% in 3Q. EUR/GBP .8905 off 0.9% on the week, off 2% on the month and up 0.65% in 3Q – noise with Italy offsetting Brexit stories and 1.28-1.33 range holding.
• CHF: .9815 up 2.3% on the week, up 0.55% on the month and off 1.6% in 3Q. EUR/CHF 1.1400 up 1.2% on the week – pointing to SNB offsetting Italy fear with 1M off 0.2% and 3M off 1.25% - CHF is back as safe-haven and lost battle with JPY.
• AUD: .7225 off 0.9% on the week, off 1.55% on the month and off 1.75% in 3Q. NZD .6620 off 1% on the week, off 1.3% on the month and 2.05% in 3Q. Both are about China with rate policy key as well - .7050-.7350 A$ new range.
• CAD: 1.2910 off 0.1% on the week, off 0.2% on the month and off 2.6% in 3Q – mostly on BOC and NAFTA hopes. Still watching 1.2880-1.3250 for bigger moves.

Commodities:

The S&P/GSCI total return index rose 2.67% to 2,859.44 on the week.

• Oil: $73.25 up 3.49% on the week – extending the breakout over $70 with $75 and $78 next key levels. Brent up 4.99% to $82.73 on the week. US sanctions on Iran, troubles in Venezuela, OPEC rebuke to Trump on output and stable growth driving.
• Gold: $1190.88 off 0.75% on the week – failing to break over 55-day at $1206 and leaving $1183 and $1160 back in play. Silver $14.66 up 2.45% on the week – breaking $14.555 resistance opening up $15 test. Platinum off 1.45% to $815.95 – losing on trade fears – while Palladium up 2.1% to $1075.
• Corn: $356.25 off 0.3% on the week. Wheat off 2.45% to $509 and Soybeans off 0.2% to $845.50 – end of harvest for corn and soybeans leaving focus on USD, trade and global demand.
• Copper: $2.8160 off 2.06% on the week. Failure at $2.90 matters and equities soggy.October Iron Ore off 1.35% to $67.93 and November now $67.65.

Calendar for the Week Ahead:

The usual economic calendar for a new month with global PMI reports and US jobs leading. The China holiday week leaves much of the geopolitical trade concerns on the back burner except for the fact that Friday brings the US trade deficit. The central bank decisions – RBA and Banexico aren’t expected to move – but the FOMC speeches do matter. The EU jobs and retail sales, along with German factory orders also matter but unlikely to move markets. Rather focus will remain on Italy and its budget, UK and its Brexit, US and its ugly politics as the mid-term election campaigning goes into overdrive.

Monday, October 1: China Holiday, Australia Holiday, Global Manufacturing PMI, German retail sales

• 0630 pm Australian September AIG Manufacturing PMI 56.7p 56.4e
• 0750 pm Japan 3Q Tankan Large Manufacturing 21p 22e / Service 24p 22e / Capex Large 13.6%p 14.2%e
• 0830 pm Japan September final Manufacturing PMI 52.5p 52.9e
• 0200 am German August retail sales (m/m) -0.4%p +0.4%e
• 0300 am Swiss August retail sales (y/y) -0.3%p +0.4%e
• 0300 am Spanish August retail sales (y/y) -0.4%p -0.9%e
• 0315 am Spanish September Manufacturing PMI 53p 52.6e
• 0330 am Italy September Manufacturing PMI 50.1p 50.5e
• 0350 am French September final Manufacturing PMI 53.5p 52.5e
• 0355 am German September final Manufacturing PMI 55.9p 53.7e
• 0400 am Eurozone September final Manufacturing PMI 54.6p 53.3e
• 0430 am UK September Manufacturing PMI 52.8p 53.8e
• 0430 am UK August mortgage approvals 64.77k p 64.5k e / Cons. Credit G817mn p G1.38bn e
• 0500 am Eurozone August unemployment rate 8.2%p 8.2%e
• 0900 am Atlanta Fed Bostic Speech
• 0930 am Canada September RBC Manufacturing PMI 56.8p 56.6e
• 0945 am US September final Manufacturing PMI 54.7p 55.4e
• 1000 am US September Manufacturing ISM 61.3p 60.5e / prices paid 72.1p 70.8e
• 1000 am US August Construction Spending 0.1%p 0.5%e
• 1215 am Boston Fed Rosengren Speech

Tuesday, October 2: China Holiday, RBA rate decision, Powell speech, US auto sales

• 0500 pm New Zealand 3Q NZIER Business Confidence -20%p
• 1230 am RBA rate decision and statement – no change expected from 1.5%
• 0100 am Japan September Consumer Confidence 43.3p 43.4e
• 0300 am Spanish Sep unemployment change 47k p 22k e
• 0430 am UK September Construction PMI 52.9p 52.6e
• 0500 am Eurozone August PPI (m/m) 0.4%p 0.0%e (y/y) 4%p 3.9%e
• 1000 am Fed VC Quarles testimony
• 1200 pm Fed Chair Powell speech
• 0330 pm US September total vehicle sales 16.72mn p 16.8mn e
• 0430 pm US weekly API oil stocks 2.90mb p 0.1mb e

Wednesday, October 3: China Holiday, German Holiday, Global Service PMI, Fed Speakers

• 0630 pm Australia Sep Service PMI 52.2p 53.8e
• 0830 pm Japan Sep Service PMI 51.5p 51.8e
• 0315 am Spanish Sep Service PMI 52.7p 52.9e
• 0330 am Italy Sep Service PMI 52.6p 52.8e
• 0350 am French Sep final Service PMI 54.4p 54.3e / Composite 54.9p 53.6e
• 0355 am German Sep final Service PMI 55p 56.5e / Composite 55.6p 56.5e
• 0400 am Eurozone Sep Final Service PMI 54.4p 54.7e / Composite 54.5p 54.2e
• 0430 am UK Sep Service PMI 54.3p 54e
• 0500 am Eurozone August retail sales (m/m) -0.2%p +0.2%e (y/y) 1.1%p 1.6%e
• 0630 am Chicago Fed Evans Speech
• 0805 am Richmond Fed Barkin Speech
• 0815 am US Sep ADP employment change 163k p 185k e
• 0945 am US Sep final Service PMI 54.7p 53.4e / Composite 53.4p 54.1e
• 1000 am US Sep Service ISM 58.5p 58.1e
• 1030 am US weekly EAI crude oil stocks 1.853mb p -1.27mb e
• 0200 pm Fed Gov Brainard speech
• 0215 pm Cleveland Fed Mester speech

Thursday, October 4: China Holiday, Australia trade, US factory orders

• 0830 pm Australia Aug trade surplus A$1.55bn p A$1.4bn e
• 0440 am Spain sells 3Y-5Y-10Y bonds
• 0500 am French 10Y OAT sale
• 0830 am US weekly jobless claims 214k p 210k e
• 0915 am Fed VC Quarles speech
• 1000 am US Aug Factory Orders (m/m) -0.8%p +0.9%e / ex autos 0.2%p 0.4%e
• 1000 am Canada Sep Ivey PMI 61.9p 61.4e
• 0300 pm Bank of Mexico rate decision – no change from 7.75% expected.

Friday, October 5: German PPI, factory orders, US jobs and trade reports, Canada jobs and trade.

• 0730 pm Japan Aug household spending (m/m) -1.1%p 0.4%e (y/y) 0.1%p -0.9%e
• 0830 pm Australia Aug retail sales (m/m) 0%p 0.3%e
• 0100 am Japan Aug LEI 103.9p 103.7e / coincident 116.1p 117.1e
• 0200 am German Aug PPI (m/m) 0.2%p 0.2%e (y/y) 3%p 2.9%e
• 0200 am German Aug factory orders (m/m) -0.9%p 0.3%e
• 0245 am French Aug trade deficit E3.49bn p E5.7bn e / C/A E0.5bpp E1.5bn e
• 0300 am Spanish Aug industrial output (y/y) 0.5%p 1.6%e
• 0315 am Swiss Sep CPI (m/m) 0%p 0%e (y/y) 1.2%p 1.1%e
• 0400 am Italy Aug retail sales (m/m) -0.1%p (y/y) -0.6%p +0.5%e
• 0830 am US Sep non-farm payrolls 201k p 185k e / AHE (m/m) 0.4%p 0.3%e (y/y) 2.9%p 3.0%e / UR 3.9%p 3.8%e / participation rate 62.7%p 62.6%e
• 0830 am US Aug trade deficit $50.1bn p $53.0bn e
• 0830 am Canada Sep employment -51.6k p +25k e / rate 6%p 5.9%e / participation 65.3%p 65.3%e
• 0830 am Canada Aug trade deficit C$0.11bn p C$1.4bn e
• 0300 pm US Aug consumer credit $16.65bn p $15bn e

Conclusions: Is Oil the new risk barometer? 

The squeeze up in oil over $80 in Brent flies in the face of Trump pleas on OPEC to continue to keep output tight. Iran sanctions and Venezuela government implosions are the underlying drivers. The politics of the moment are in play as Trump called the Saudi King Salman bin Abulaziz on Saturday. Trump may be the most interventionist President yet in markets. He clearly wants to cap the energy pain ahead of the US mid-term elections and this is one tool – using foreign policy buttons to get his way.

The other risks for the market revolve around foreign exchange with the USD move up likely to add to his displeasure on what it means for growth potential into 2019. Expect further rhetoric from him on the FOMC hikes and the USD bid tone. The power of oil and the USD both going up makes sense in a world retreating from China. Perhaps this is just temporary given the China futures markets on CNY gold back oil contracts is closed all week, or perhaps this is a sign that the risk off mood that held last week extends as global growth doubts rise with trade concerns. Oil may be the key to watch for such risks.