For most of the week, the financial markets traded in response to economic and financial news from China. On Monday, the Great Wall of China turned into the Great Fall of China as the Shanghai Composite Index fell off of a cliff in overnight trading to lead global stock markets significantly lower. The Shanghai Composite’s 8.5% nose dive was its worst decline since 2007, and resulted in multiple trading halts in our S&P 500 Index and Nasdaq 100 Index futures markets before our stock market’s opening bell. Once the opening bell did arrive, the Dow Jones Industrial Average plunged 1,080 points, the NASDAQ fell 413 points, and the S&P 500 Index dropped 103 points within a few minutes.
The stock market then spent the rest of the session reversing higher from its intraday lows. The panic-driven financial markets resulted in safe-haven U.S. Treasuries rallying with the 10-year yield tumbling to an intraday low of 1.94% before pulling back up to close at 1.998% as widespread fears of a China-led economic slowdown circulated around the globe.
China remained in the headlines on Tuesday as their central bank, the People’s Bank of China, cut their primary lending rate by 25 basis points to 4.6%, their banking system’s reserve requirement ratio by 50 basis points to 18% and one-year deposit rates by 25 basis points in an effort to stimulate their weakening economy. The announcement from China’s central bank took sent U.S. stock index futures sailing to new pre-market highs and stocks did trade higher for most of the day before selling off hard in the last hour of trading.
Tuesday’s economic reports were generally supportive for the stock market. Of particular interest, the Census Bureau reported New Home Sales for July came in at 507,000 annualized units. While just shy of the consensus forecast of 511,000 units, this was an increase of 5.4% from the downwardly revised June rate of 481,000 and an increase of 25.8% compared with the July 2014 rate of 403,000. The median sales price for new homes sold in July fell to $285,900 and the average sales price was $361,600. At the end of July, the number of new homes for sale totaled 218,000 and represented a supply of 5.2 months at the current sales rate.
Also in housing news, the S&P/Case-Shiller home price index and the Federal Housing Finance Agency house price index for June were both reported. The S&P/Case-Shiller home price index for June increased by 5.0% year-over-year for the 20-city composite index and by 4.6% for the 10-city composite index. The national index rose 4.5% year-over-year, compared with a 4.4% gain in May. The consensus estimate for the year-over-year 20-city index called for growth of 5.1%.
The Federal Housing Finance Agency house price index edged 0.2% higher in June. Although slightly below a low-end forecast for 0.3%, it was still a decent gain. Annualized price growth was reported at 5.6%, while prices in the second quarter increased 5.4% compared to the second quarter of 2014. Sales rates are taking place at about twice the rate of price growth, a disparity suggesting future price acceleration given how thin inventories are right now in the housing sector.
Wednesday appeared to be a day of déjà vu as the markets traded very similar to Tuesday with the exception stocks held onto their gains rather than selling off during the last hour of trading. China’s government injected a new round of stimulus into their markets by lowering interest rates by another 25 basis points and the reserve requirement ratio (RRR) for the largest banks by an additional 50 basis points. Like Tuesday, the stock market rejoiced over the China monetary easing news and opened significantly higher while the bond market came under selling pressure. Bonds then came under additional selling pressure following a weak 5-year Treasury note auction in the afternoon.
Helping the stock market were public comments made by New York Fed President William Dudley when he said “At this moment, the decision to begin the normalization process at the September FOMC meeting seems less compelling to me than it was a few weeks ago.” However, he left the door open to raising rates during the September 16-17 FOMC meeting when he went on to say an initial rate hike “could become more compelling by the time of the meeting as we get additional information on how the U.S. economy is performing and international financial market developments, all of which are important to shaping the U.S. economic outlook.” Dudley, a known “dove” on the FOMC and a close ally of Fed Chair Janet Yellen, was likely inferring that the economic slowdown in China and corresponding upheaval in the financial markets could influence the Fed’s monetary policy.
Also on Wednesday, the Mortgage Bankers Association released their Mortgage Application Data for the week ending August 22. Overall the Index increased +0.2%. The Refinance Index decreased 1.0% from the prior week, while the seasonally adjusted Purchase Index increased by 2.0% from a week earlier. Overall, the refinance portion of mortgage activity fell to 55.3% from 55.5% of total applications the previous week. The adjustable-rate mortgage segment of activity decreased to 6.8% of total applications from 6.9% in the prior week. The average contract interest rate for 30-year fixed-rate mortgages with conforming loan balance dropped from 4.11% to 4.08%.
Thursday, bond prices continued lower with benchmark yields reaching one-week highs as a recovery in global stock markets saw some follow-through from Wednesday’s robust rally. Resilient economic data led by a surprisingly strong revision to second-quarter GDP fueled selling in government debt. The Commerce Department reported gross domestic product (GDP) grew at a 3.7% annual rate during the second quarter, and at faster pace than the 2.3% rate initially reported. The consensus forecast had called for 2nd Quarter GDP to be revised higher to 3.2%.
The stock market continued its rally on good economic data, overnight signs of market stability in China, and after New York Federal Reserve President William Dudley said yesterday that the prospect of a September rate hike “seems less compelling to me than it was a few weeks ago” due to the recent chaos in global markets. Following up on Dudley’s comments, Kansas City Fed President Esther George told Fox Business Network that the Fed should take a “wait and see” approach on hiking rates, while a top Chinese central bank official told Reuters the Federal Reserve would harm the global economy if it were to raise rates prematurely.
Housing remained an encouraging sector Thursday as the National Association of Realtors reported Pending Home Sales Index increased 0.5% in July to 110.9 from an upwardly revised June reading of 110.4. The index has now risen for six of the past seven months, and July recorded the third highest reading for 2015 to date. The consensus forecast called for a month-over-month increase of 1% for Pending Sales. An index reading of 100 equals the average level of contract signings during 2001 and the index has now been above 100 (the “average” reading) for 11 straight months. The national median existing-home price for all housing in 2015 is expected to increase around 6.3% to $221,400, down by $500 from the June projection. Total existing-home sales this year are forecast to increase 7.1% to around 5.29 million, about 25% below the prior peak of 7.08 million reached in 2005, but up from a total of 5.27 million projected in June.
Friday, the financial markets acted rather restrained, perhaps exhausted after enduring all of the volatility that took place over the prior four trading days. Signs of market stability in China seemed to have calmed global equity markets as the Shanghai Composite Index gained more than 4.0% for a second consecutive day. Chinese officials announced pension funds managed by local governments will start investing 2 trillion yuan or $313.05 billion as soon as possible in stocks and other assets and this seemed to provide a boost to investor sentiment.
The day’s economic news was mostly aligned with consensus estimates. Personal Income increased +0.4% in July, while Personal Spending rose 0.3%. Personal Income matched the consensus forecast while Spending was estimated at a slightly higher 0.4%. The Core PCE Price Index crept up just 0.1% higher matching expectations. The Core PCE Index, the Fed’s favorite inflation measure, indicates inflation is not yet becoming a problem and this may be helping investor sentiment today.
Furthermore, the final reading of the University of Michigan’s Consumer Sentiment Index was reported at 91.9 for the month of August, which was slightly weaker than the consensus forecast of 93.0, but still a strong value.
For the week, the FNMA 3.5% coupon bond lost 34.4 basis points to end at $103.75 while the 10-year Treasury yield climbed 13.9 basis points to end at 2.18%. Stocks ended the week with the NASDAQ Composite gaining 122.29 points to close at 4,828.33. The Dow Jones Industrial Average added 183.26 points to end at 16,643.01, and the S&P 500 increased 17.98 points to close at 1,988.87.
Year to date, and exclusive of any dividends, the NASDAQ Composite has gained 1.91%, the Dow Jones Industrial Average has dropped 7.09%, and the S&P 500 has fallen 3.52%. The national average 30-year mortgage rate moved to 3.98% from 3.93% while the 15-year mortgage rate increased to 3.25% from 3.19%. The 5/1 ARM mortgage rate rose to 2.98% from 2.96%. FHA 30-year rates rose to 3.75% from 3.60% while Jumbo 30-year rates increased to 3.80% from 3.72%.
Mortgage Rate Forecast with Chart
For the week, the FNMA 30-year 3.5% coupon bond ($103.75, -34.4 bp) traded within a 108 basis point range between a weekly intraday high of 104.66 and a weekly intraday low of $103.58 before closing at $103.75 on Friday.
Volatility reigned supreme with the bond trading within wide intraday swings during the week. After rocketing well above the 200-day moving average resistance level located at $104.12 to reach an intraday high of $104.66 on Monday, the bond pulled back late in the session to close at $104.22 in a sign of internal market weakness. The bond then spent the rest of the week testing converging support levels from the 100-day and 25-day moving averages located at $103.72 and $103.65 respectively.
A new sell signal was generated as a result of last Tuesday’s trading from a negative stochastic crossover in the slow stochastic oscillator which is now trending lower indicating a slowing in market momentum. Overhead technical resistance continues at the 200-day moving average which has proven in the past to be an extremely tough ceiling since the beginning of June.
As long as the dual layer of support from the 100 and 25-day moving averages hold, the bond should be range-bound in the coming week between support and resistance levels with little overall change in mortgage rates.
Chart: FNMA 30-Year 3.5% Coupon Bond
Economic Calendar – for the Week of August 31
The economic calendar focuses on the latest labor and employment data this week highlighted by the ADP Employment Change for August on Wednesday; the August Challenger Job Cuts and Initial Jobless Claims reports on Thursday; and the Labor Department’s Employment Situation Summary for August on Friday. Economic reports having the greatest potential impact on the financial markets this coming week are highlighted in bold.
Road Signs – How a Chinese slowdown will hit global growth
By Linda Yueh, Fellow in Economics/Adjunct Professor of Economics at University of Oxford
As China’s markets fall and drag down global equities, the underlying concern is undoubtedly how much a slowdown in the Chinese economy will affect the rest of the world. Since the 2008 global financial crisis, China has notably emerged as one of the twin engines of world growth.
China has contributed as much to world GDP growth as the US in the past decade and a half, and even more than the world’s biggest economy since the 2008 financial crisis, according to the IMF. Indeed, the IMF projects that China will generate around double what the US contributes to world output until the end of the decade. Together, the US and China are expected to generate as much world output as the rest of the world put together.
Prior to China integrating with the world economy, the US was the biggest and sole engine of global growth as it accounted for nearly a quarter of world GDP, based on market exchange rates. So, it’s the rapid growth of China, which rose from accounting for a mere 2% of world GDP in 1995 to around 15% now, that helped the world economy grow so quickly in the 2000s.
As China slows from the nearly 10% growth rate that it clocked in the first three decades of its reform period, which began in 1979, to what is thought to be a more sustainable 7% or so, the world economy is likely to slow with it. The main areas where the impact will be felt would include not only commodities, but also consumer goods, including luxury goods.
China’s re-balancing of its economy means that consumption (what consumers buy) will become a bigger part of the domestic economy than investment, and services will become a more important driver of growth than manufacturing. As a result, a Chinese slowdown will affect not just commodities and capital goods, but also global consumer demand and thus the profits of multinational companies in America and Europe. Here’s a breakdown of the most affected:
- Commodities exporters
The countries most affected by a Chinese slowdown are still likely to be those that export a great deal to China, notably commodity exporters such as Australia. As Chinese demand for raw materials and commodities decline, there will be a knock-on effect in terms of their economic growth.
For Australia, China accounts for around one-third of all exports.
For Sub-Saharan Africa, China is the largest trade partner, accounting for around one-eighth of all trade. But the impact will be concentrated since five countries account for three-quarters of all of Africa’s exports to China: Angola, the Democratic Republic of the Congo, Equatorial Guinea, Republic of Congo, and South Africa.
China has surpassed the US as the most important trading partner for Latin America, which has traditionally been seen as America’s backyard and therefore most susceptible to the economic fortunes of its northern neighbor. But that is no longer the case. Latin American exports to China have risen to account for a record 2% of the GDP of the region.
As China’s growth slows, its imports have fallen by 8% from a year ago, as seen in the latest data for July, following a similarly sizeable 6% drop in June. The slowdown has been felt in the commodity price falls seen throughout the summer that has led to tens of thousands of job losses by oil and coal companies globally, as well as others.
But, it’s not just commodities. Capital goods imports have also fallen, which will affect countries like Germany where exports to China account for around 2% of GDP. Germany itself accounts for the bulk of EU exports to China so the largest country in Europe, which has recovered on the back of exports, will also feel the impact.
Indeed, the European Union is China’s largest trading partner, and China is the second-largest trading partner of the EU after only the US. So, a slowdown in China will affect Europe, which is also felt in the profit warnings issued by European companies such as Burberry and BMW as their sales in China slow.
- The USA
Exports from the US to China, by contrast, are less than 1% of GDP. That stands in contrast to Japan where exports to China amount to a large 3% of GDP.
But that doesn’t mean that American multinationals will be unaffected. For instance, the world’s most valuable company, Apple, sells more iPhones in China than the US, and its CEO has reassured markets more than once that the Chinese slowdown won’t negatively affect their business.
- Financial markets
Finally, the Chinese slowdown has been most visibly seen in financial markets. China’s stock market is largely closed to outside investors so does not have a direct impact on global investors. But, despite rebounding from their initial fall, equities markets are certainly reacting to the impact of a Chinese slowdown.
The UK’s FTSE will feel this most acutely, as it has a large portion of commodity stocks and around half are multinational companies, making it one of the most open bourses in the world. No wonder UK stocks experienced their worst one-day fall since the 2008 financial crisis when China’s market tanked.
Undoubtedly it’s unusual for the world’s second-largest economy to be a middle-income country that is not entirely market-driven. Given the importance of China to the world economy, it’s time to get used to monitoring China as well as the US even more closely and becoming accustomed to the greater ups and downs that are likely to be seen in the global economy as a result.