Investors enter 2019 remaining increasingly uncertain about where sovereign bond markets are heading given the confused interplay between interest rates, growth, and inflation that intensified in Q4, 2018.
The knock on effect from US interest rates will have a material impact on the dollar and equity markets. Thus, it's a necessity that the markets are focused firmly on the Fed.
Despite Fed officials continuing to express confidence in the U.S economy, the market remains worried that even though the Fed has scaled back its rate-raising plans for 2019, higher interest rates still pose a risk to expansion.
Note: The Fed last month had penciled in two hikes for 2019, rather than the three officials predicted in September. However, the market sees things differently, fixed income dealers have priced out any additional hikes this year with Fed fund futures implying no change and a -25 bps cut in 2020.
It's not just the Fed actions that will have an impact on volatility, but it's what they will also say in 2019. Investors need to keep an eye on the Fed's own messaging — Chairman Jermone Powell will have the opportunity to once again lay out the Fed's direction for 2019 as he joins Janet Yellen and Ben Bernanke for a joint discussion this Friday at 10:15AM EDT.
Officials have signalled they intend to rely more on recent economic data in setting interest rates and coupled with Fed Chair Powell's intention to hold news conferences after every FOMC policy meeting will only add to the volatility.
The new year started on the back foot with global equities under pressure after disappointing Chinese data overnight has ruined investors hopes for an upbeat start to 2019 — safe havens including gold, Euro bonds and the yen have benefited in early trading.
With all this in mind, here are five things the global markets were talking about on Wednesday morning.
1. Global Equities Suffer From A Hangover
Disappointing data from the world's second largest economy overnight is causing global equity markets to begin 2019 on the back foot. A private sector survey showed China manufacturing activity contracted for the first time in 19-months. The Caixin/Markit Manufacturing Purchasing Managers' Index (PMI) for December fell to 49.7, from 50.2 m/m.
In Japan, equities were lower after the close this morning, as Pharma, Retail and Power sector losses took the lead lower. At the close, the Nikkei 225 fell -0.31 percent.
Down-under, Australian stocks kicked off the New Year in the red, pressured by disappointing Chinese data – China is Australia's largest trading partner and the AUD trades as a proxy for China economic growth. The S&P/ASX 200 index closed 1.6 percent lower. The benchmark ended 0.1 percent lower on Monday.
In China and Hong Kong, stocks slumped in their first trading session as investors digested the disappointing data, adding to concerns over trade and an economic slowdown. In China the blue-chip CSI300 index fell 1.4 percent, while the Shanghai Composite Index ended down 1.1 percent. In Hong Kong, at the close of trade, the Hang Seng index was down 2.77 percent, while the Hang Seng China Enterprises index fell 2.87 percent.
2. Oil Shows Losses On Signs Of Economic Slowdown
Oil markets start the New Year on the back foot, pulled down by surging US output and concerns about an economic slowdown in 2019 as factory activity in China, the world's biggest oil importer, contracted.
Brent crude futures were at $53.19 per barrel, down 1.1 percent, from their final close of 2018. West Texas Intermediate (WTI) futures were down 1 percent at $44.95 per barrel.
A number of factors are expected to provide heightened volatility in the commodity space in Q1, 2019. Geopolitically, there is the markets uncertainty on Sino-US trade, Brexit and conflict in the Middle East. There is also the matter of US shale output numbers and OPEC's and Russia's supply discipline. All factors that are expected to have a meaningful impact on energy price in H1.
3. Sovereign Yields Buckle
A disappointing Chinese PMI print overnight is keeping the demand for safety going, especially for German Bunds.
Overnight, German government Bund yields dropped to its lowest in 20-months as investors piled into one of the safest assets in the world on the back of widening stock market weakness and a gloomy global growth outlook.
The yield on Germany's 10-year debt briefly dropped to 0.17 percent, it's lowest since April 2017, before edging up to 0.183 percent, down 6 bps. The German 2-10 spread is at its tightest in over two years at 79.90 bps.
On the horizon, supply will be an important factor for eurozone bond markets this month as countries start their annual funding programs.
Elsewhere, the yield on US 10-year bonds ticked up less than 1 bps to 2.69 percent, the largest advance in a week. In the UK, the 10-year Gilt yield fell 3 bps to 1.25 percent, the lowest in almost three weeks, while the spread of Italy's 10-year bonds over Germany's rallied 4 bps to 2.53 percent, the biggest premium in a week.
4. Lower Yields Put The Dollar Under Pressure
The mighty dollar has been dragged down by a steep fall in US Treasury yields over the last month, as well as the market pricing in no more rate hikes in 2019, even though last month the Fed projected at least two more hikes.
The safe-haven yen extended its broad rally as the dollar dropped to ¥109.37 in the overnight session, its lowest since June last year.
Elsewhere, the Australian Dollar, often used as a proxy for China sentiment, lost as much as 0.7 percent overnight, to print its lowest since February 2016 at A$0.7001.
5. UK Factories Build Up Stockpiles Before Brexit
Data released Wednesday morning showed that UK factories ramped up their stockpiling last month as they prepared for possible border delays when Britain leaves the EU in less than three months' time.
The IHS Markit/CIPS Manufacturing Purchasing Managers' Index (PMI) rose to 54.2 from an upwardly revised 53.6 in November, the highest reading in six-months and stronger than all forecasts.
Markit said "the improvement did not herald a big change in the outlook for Britain's stuttering economy and was caused in large part by manufacturers stockpiling inputs and finished goods, both of which were near record highs."
It's worth noting that in December the Bank of England (BoE) cut its forecasts for quarterly growth to just 0.2 percent in Q4 of 2018 and Q1 of 2019. It has warned that a worst-case Brexit could push Britain into a deep recession.
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