October 4, 2019

Breakingviews: Investors are too lighthearted about sober October

by Breakingviews.

Bad economic data emerges, stock markets fall. Investors then predict an interest-rate cut, and stocks rise. That circular interpretation of Thursday’s trading day in the United States may be too neat. With the S&P 500 Index and other benchmarks higher on the day, it certainly looks too sanguine.

The Institute for Supply Management’s index for the U.S. services sector came in far below what economists polled by Reuters had expected. An earlier reading for the manufacturing sector signaled a contraction. That’s not entirely surprising. Expansion was bound to moderate eventually, after 11 years of steady growth.

Even so, sober October has set in with alarming speed. A new front in President Donald Trump’s trade war opened on Wednesday when the United States laid out tariffs on $7.5 billion of imports from Europe, from cookies to knitwear, in retaliation for EU subsidies to aircraft-maker Airbus. Economists estimate 145,000 jobs were added in September – the second-lowest number they’ve forecast in almost six years.

The employment data will be out on Friday. If reports continue to show relative weakness, it will heap pressure on Federal Reserve chief Jay Powell. Trading on Thursday implied a 90% probability of another rate cut following the central bank’s Oct. 29-30 meeting, according to the CME FedWatch tool – almost double the likelihood a week earlier.

The U.S. economy isn’t yet heading for recession – annualized GDP growth is estimated at 2% and 1.9% for the next two quarters, according to the Conference Board. Even if a downturn comes, it’s unlikely to be as deep as the subprime mortgage-fueled financial crisis.

Yet monetary policy has limits, as Powell has noted. Faster-acting fiscal measures are needed too, whether that’s tax cuts, extended unemployment payments or infrastructure programs. Mario Draghi, outgoing boss of the European Central Bank, has made the same point to European leaders. Such stimulus moves require government action, in America’s case from Congress.

That was elusive before, but as Democrats push harder to impeach the president, consensus becomes close to impossible. The fact that markets closed up in the end on Thursday suggests investors are assuming the Fed will do enough. They ought to be worrying that it can’t.

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