Investors climbed a wall of worry last week but made little headway higher. The focus was on better earnings against the usual global economic and political concerns.

China produced a weaker GDP for 3Q than expected but announced stock supportive measures and further stimulus plans. Europe had another bout of Italian budget and political fears but no new pain for BTPs. In fact, the Friday Moody’s cut to Baa3 – the last rung of investment grade – removes fears of junk status for now and makes ECB reinvestment buying not an issue in 2019.

The UK had another disappointment with Brexit deals and the EU but nothing new for GBP. The Saudi intrigue over the death of Washington Post journalist Khashogghi continued to nag oil and technology as fears over sanctions remain in play but US actions were slow and inventories plentiful driving down the price of oil.

Next week, the easy money policies that have dominated since the great recession of 2008 are the focus as the BOC, ECB, Riksbank all meet to decide on rates with their forward guidance the key tool to watch. Last week brought the FOMC minutes and they were hawkish enough to spook markets but not enough to sustain a further move down in bonds as equities counterbalanced and the strange moderation of moves left everyone trading taking a moment to consider the next move.

Politics in the US continue to face the mid-term election risks and Trump continues to campaign, with weekend talk of a middle-income tax cut sweetener adding to the fears about deficits and the significant borrowing in the week ahead. All of which leaves equities treading water, rotating sectors without much forward progress to break out of the 2650-2850 S&P 500 range but with many expecting more volatility as the waves of doubt from last week all remain in play.

What Happened over the Weekend?

• Italy and the Budget: Can’t ignore BTP higher yields effect on banks. “The increase in the (bond yield) spread, the amount of public debt banks hold and new European Union banking rules put the industry under pressure and may generate the need to recapitalizes the most fragile lenders,” the undersecretary for the PM, Giancarlo Giorgetti , told Italian daily Il Messaggero in an interview published Sunday. He also said that next year’s budget deficit may turn out to be lower than the proposed 2.4 percent of gross domestic output. Italian Leaders plan to stay with EUR and stick with budget. “As long as I remain political head of the Five Star Movement and as long as there is this government there is no will on our part to leave the European Union or the eurozone,” Mr Di Maio said on Saturday after the two leaders reached an agreement over the details of a tax amnesty policy that had caused friction within the coalition earlier in the week.
• UK and Brexit: Raab open-minded about extending transition. “If we need a bridge from the end of the implementation period to the future relationship...I am open minded about using a short extension of the implementation period,” UK Brexit Secretary Raab told BBC TV.  “It is an obvious possible route as long as it is short, perhaps a few months, and secondly that we know how we get out of it and obviously it has to solve the backstop issue so that that falls away then as a possibility.”  
• French Minister: EU can’t accept temporary Irish Border measures. “We have to have a definitive answer or at least no temporary measures which disappear and we don’t know what to do after that,” French minister for EU affairs, Loiseau told BBC TV.  “This is something that has to be fixed by London ... We are waiting for a workable solution coming from London.” 
• UK sees thousands march in London for “people’s vote” on Brexit.  Young voters led the People's Vote march to London's Parliament Square, which supporters say attracted approximately 700,000 protesters, BBC News reports. The Metropolitan Police said it was not able to estimate the size of the crowd.  "What's clear is that the only options on the table now from the prime minister are a bad Brexit deal, or no deal whatsoever," London Mayor Sadiq Khan, who joined the march, told the BBC. "That's a million miles away from what was promised 2 1/2 years ago."
• Saudi and Khashoggi: Another version of his death, more pushback from US/EU/UK. The latest account, provided by a Saudi official who requested anonymity, includes details on how the team of 15 Saudi nationals sent to confront Khashoggi on Oct. 2 had threatened him with being drugged and kidnapped and then killed him in a chokehold when he resisted. A member of the team then dressed in Khashoggi’s clothes to make it appear as if he had left the consulate.  After denying any involvement in the disappearance of Khashoggi, 59, for two weeks, Saudi Arabia on Saturday morning said he had died in a fistfight at the consulate. An hour later, another Saudi official attributed the death to a chokehold, which the senior official reiterated. 
• US President Trump calls Saudi explanation deceptive and “all over the place,” not satisfied.  In a Washington Post article published late Saturday, the US President said that "obviously there's been deception and there's been lies," when asked about Saudi Arabia's account of the killing of Khashoggi inside their Istanbul consulate almost three weeks ago. "Their stories are all over the place," Trump said.
• US and Russia: Trump plans to pull US out of nuclear missile treaty. Speaking to reporters, Mr. Trump said Russia had "violated" the 1987 Intermediate-Range Nuclear Forces (INF) treaty. The US would not let Russia "go out and do weapons [while] we're not allowed to", Mr Trump said.  "I don't know why President [Barack] Obama didn't negotiate or pull out," the president said after a campaign rally in Nevada. "They've been violating it for many years."

Question for the Week Ahead: 

Can earnings and growth trump trade and rates and politics to keep US markets risk-on?

If last week was a balancing act, the next week is going to be a high-wire version as US earnings continue while trade policy fears continue as the US/EU talks splintered last week, as Mexico/US steel quota discussions stalled and as China digs in with more stimulus and easy money plans.

Waiting out the trade policy fears as mere noise continues to be the consensus, leaving rates as the more likely pain maker, but FOMC minutes last week were not sufficient to break the 3.25% 10-year yield line and leave many expecting more consolidation and stock market rotation plays into the other fear-mongering event – US mid-term elections.

The debate about risk revolves around when and if inflation matters to the Fed, about financial conditions and when a lower stock market matters to them and about trade policy and when it shows up in either lower growth or higher prices. The fear that the US economy is in the later stages of its long recovery drives much of the mood and yet the bulls still point to corporate profit margins. If this was the later stage of a business cycle, margins should be narrowing. 

The reaction function of the FOMC to growth and inflation has supported the USD and the last week reflects this clearly. The threat of higher inflation from commodities remains part of the puzzle, with oil still up significantly on the year (+20% ytd for Brent). The relationship of the USD to industrial commodities is also worth considering and here the Dr. Copper story supports the view that stocks may hold at least until the November vote.

The divergence between actual trade growth as shown by the US and China and others vs. fears in the months ahead remains a key part of the risk-off argument.Sentiment in the months ahead as shown by the ICC (international chamber of commerce) survey – regulation, sanctions, fin-tech disruptions and then trade tariffs are the drivers. 

The focus on the US mid-term elections isn’t just about hype – it’s clearly reflecting the zeitgeist of public opinion with the effort of both parties to turn out voters to improve their chances in what is becoming a tight battle to control Congress. The NBC/WSJ poll is worth reading as the polls begin to be priced into markets for November.

Market Recap:  

News flows wrapped around the China CPI/PPI, trade and 3Q GDP along with industrial production and retail sales. The net result was 6.5% GDP was low enough to cause the government to announce new measures to support equities. As for the US, the week wrapped around the FOMC minutes with the 3 hikes more in 2019 not yet priced by the market but clearly the consensus of the Fed.

Hawkish discussions of higher rates did hurt stocks and bonds but not for long as earnings made up for the difference. EU/US trade talks didn’t fair well, nor did EU/UK Brexit talks. The data in Europe was mixed at best with auto registrations diving but confidence mostly holding. Japan exports dropped and highlighted fears about broader US trade war pain.

Equities:

The MSCI all-country World Index fell 0.14% to 494.05 on the week. The MSCI EM index fell 0.89% to 971.47 on the week.  FactSet calculates with just 17% of companies in the S&P500 reporting, 80% have beaten earnings expectations and 64% have beaten sales. The 3Q blended earnings growth is 19.5% up from 19.3% at the start of the 3Q. There are 158 companies reporting next week.

• The US S&P 500 rose 0.02% to 2767.78 on the week, squeaking out a gain after a volatile week. The DJIA rose 0.41% to 25,444.34 on the week while the NASDAQ lost 0.64% to 7,449.03 on the week. The Cboe Vix fell to 19.89% off 6.66% on the week after testing 22.25% highs Monday. Companies representing about 14% of the S&P 500’s market cap reported earnings during the week. Results from Morgan Stanley and Goldman Sachs in the financial sector surpassed analysts’ estimates and helped drive Tuesday’s 2.15% gain in the S&P 500. Technology and related stocks remained under pressure and reflected technical doubts and Saudi fears.
• The Stoxx Europe 600 rose 0.64% to 361.70 on the week, but is off 6% on the month and 7.18% on the year-to-date. Italy again led the losers with FTSE MIB off 0.91% to 19,080.16 on the week. Swiss and UK led the winners with the UK FTSE up 0.77% to 7,049.80. The German DAX rose 0.26% to 11,553.83 on the week while the French CAC40 fell 0.22% to 5,084.66.
• The MSCI Asia Pacific Index fell 0.78% to 153.06 on the week. The biggest loser was China with the Shanghai Composite off 2.17% to 2550.47 on the week – but the Friday 2.58% bounce back was notable after government stimulus plans/stock focused support followed. The India Nifty 50 rose 0.67% to 10,303.55 and the Hong Kong Hang Seng rose 1.17% to 25,561.40 both leading the major bourses for the week. The Japan Nikkei 225 fell 0.72% to 22,532.08 while the Topix fell 0.56% to 1692.85 on the week. The Korea Kospi fell 0.26% to 2156.26 while the Australian ASX 200 rose 0.74% to 5939.49.

Fixed Income:

The balancing act of negative equities, ongoing political issues from trade to Italian budgets to Brexit all supporting safe-haven bonds clashed with the FOMC meeting minutes, the stronger US data and the promises for more stimulus from China. Issuance took its toll on Europe but US supply will be the key next week.

The lack of credit concern was also notable as US high yield held ground despite the weaker oil prices and as the Moody’s cut of Italy was the least that could be done. Spain suffered reversals after the supreme court ruled banks must pay fees on mortgages. These charges are currently being passed onto clients, costing upward of 1% of the mortgage loan. The total cost to the banks is estimated near E18-20 billion. The Japan markets focused on slower exports and business sentiment wavering into China/US trade wars effectively keeping JGBs in a dull range trade. 

• US bonds down on the week, holding range with focus on supply and data next: 2Y up 5bps to 2.904%, 3Y up 4bps to 2.982%, 5Y up 3bps to 3.046%, 10Y up 3bps to 3.192%, 30Y up 4bps to 3.376%
• Canadian 10-year bond yields flat at 2.495% for the week, focus shifts to BOC with hike priced, but CPI/Retail Sales miss and dovish hike expected.
• Japan JGBs stuck in range, 10-year yields off 0.1bps to 0.139% on the week. Focus is on stocks, US spreads.
• Australian 10-year bond yields fell 7bps to 2.677% on the week with China worries, mixed data driving.
• UK Gilt yields off 5.5 bps to 1.575% on the week with EU Brexit summit failure driving further UK political worries, data mixed with retail sales lower.
• German Bund yields fell 4 bps to 0.457% on the week with Italy, UK and China worries driving. 0.55% holding means 0.40% risks.
• French OAT yields fell 2.5 bps to 0.835% on the week with supply, Macron politics and Italy driving.
• Italy BTP yields fell 9.5 bp to 3.475% on the week with budget doubts still key but not new crisis and data ahead matters – the pull back from 4-year highs and the 3.75% looks important.
• Spain Bono yields rose 5.5bps to 1.725% on the week with supply and growth key, catch up to Italy trade in play as the high court ruling on mortgage taxes hit banks.
• Portugal 10-year bond yields fell 2 bps to 2.01% on the week – stuck with Italy and Spain and supply driving.
• Greece 10-year bond yields fell 5.5b ps to 4.305% on the week – tracking Italy and watching politics.

Foreign Exchange:

The US dollar index rose 0.5% to 95.71 on the week with 96.09 highs and focus on 97 retest risks. For Emerging Markets, the USD was mixed, EMEA: ZAR up 0.7% to 14.414, TRY up 4.1% to 5.641, RUB up 0.9% to 65.461; 

ASIA: TWD off 0.25% to 30.931, KRW off 0.1% to 1132.1 after another 1140 test this week, INR 73.325 up 0.35% on the week while CNY fell 0.15% to 6.9290 with focus on 6.95; LATAM: BRL off 1.9% to 3.711 as election joy wears off, MXN 19.283 off 2.2% with steel quota talk, ARS up 0.4% to 36.538. 

In Crpytocurrencies, USD mostly lower: BTC futures rebounded on the Tether noise – fears of depegging -  and technical – BTC up 2.85% to $6490 tests $7000 early in week. ETH up 3.2% to $207l.55. XRP (Ripple) $0.465 up 10.8% - stabilizes with $0.40 key.

• EUR: 1.1515 off 0.4% on the week with 1.1420 now key base and ECB decision main focus. 1.14-1.1580 keys.
• JPY: 112.55 up 0.3% on the week with EUR/JPY 129.60 up 0.1% with US rates and 112 still risk pivot with equities focus.
• GBP: 1.3075 off 0.6% on the week with EUR/GBP .8810 up 0.25% - GBP hit on Brexit and politics still with 1.30 pivot for 1.2800 or 1.3250.
• CHF: .9960 up 0.3% on the week with EUR/CHF 1.1470 off 0.05% - Italy not enough to drive anymore – tracking JPY.
• AUD: .7120 up 0.1% on the week but .7050-.7250 consolidation and China driving. NZD up 1.3% to .6595 on the week with CPI key event killing RBNZ easing hopes.
• CAD: 1.3105 up 0.6% on the week with CPI/Retail Sales key driver Friday, with BOC focus next and risk for 1.30 base for 1.33 test.

Commodities:

The S&P/GSCI total return index fell 1.19% to 2,798.80 on the week, still up 0.5% on the month, 9.5% year-to-date. For the week, sugar and coffee led the rally while hogs, orange juice and oil led decliners.

• Oil: $69.12 off 3.10% on the week. Brent off 0.8% to $79.78 with inventories and less fear about Saudi retaliation driving market - $70 WTI break opens $66 retest.
• Gold: $1226.50 up 0.8% on the week. Focus is on $1236 and $1250 next with USD not the only factor anymore.Silver also breaking bid up 0.3% to $14.62 with $14.50-$14.77 keys. Platinum off 0.9% to $830.95 and Palladium up 1.4% to $1083 on the week.
• Corn: $367 off 1.8% on the week. Wheat off 0.5% to $514.75 on the week. Soybeans $856.75 off 1.25% on the week. Weather dominated the week as the USMCA rally reversed from the start and harvest friendly forecasts dominated. 
• Copper: $2.8066 fell 2% on the week, with Dec futures off 0.98% to 2.7780. Some of this was linked to China and trade/industrial production, some to equities, Chile while Iron Ore rallied again up 3.5% to $72.07 Nov futures.  

Calendar for the Week Ahead:

US 3Q earnings, US bill and notes sale, flash global PMIs, more US housing data, US 3Q GDP, final Consumer Sentiment, Bank of Canada rate decision, ECB rate decision, Riksbank rate decision, Fed Beige Book, Indonesia and Russia rate decisions, German IFO, Tokyo CPI, and ECB, FED, RBA speakers.

Monday, October 22: NZ holiday

• 1000 pm RBA Debelle speech
• 0600 am German Bundesbank Monthly Report
• 0830 am US Sep Chicago Fed National Activity 0.18p 0.15e
• 0830 am Canada Aug wholesale sales (m/m) 1.5%p 0.2%e
• 1130 am US Treasury sells 3M and 6M bills

Tuesday, October 23: German PPI, US Richmond Fed, 2Y sale

• 0200 am German Sep PPI (m/m) 0.3%p 0.3%e (y/y) 3.1%p 2.9%e
• 0320 am Indonesia Central Bank rate decision no change from 5.75% expected
• 0510 am UK 10Y Gilt Sale
• 0600 am UK Oct CBI Industrial Trends Survey -1%p -1%e
• 0930 am US Minn Fed Kashkari speech
• 1000 am US Oct Richmond Fed Manufacturing 29p 25e
• 1000 am Eurozone Oct flash consumer confidence -2.9p -3.2e
• 1130 am US Treasury sells 1M bills
• 0100 pm US Treasury sell 2Y notes
• 0430 pm US weekly API crude inventories -2.1mb p +2.3mb e

Wednesday, October 24: Flash PMI reports, EU M3, Sweden Riksbank, BOC rate decision, US new home sales

• 0830 pm Japan Oct flash Manufacturing PMI 52.5p 52.1e
• 0100 am Japan Aug LEI 103.9p 104.4e / coincident 116.1p 117.5e
• 0245 am French Oct business climate 107p 108e
• 0315 am French Oct flash Manufacturing PMI 52.5p 52.6e / Service 54.8p 54.8e / Composite 54p 53.8e
• 0330 am German Oct flash Manufacturing PMI 53.7p 53.4e / Service 55.9p 55.5e / Composite 55p 54.8e
• 0330 am Sweden Riksbank rate decision – no change from -0.5% expected
• 0400 am Eurozone Oct flash Manufacturing PMI 53.2p 53e / Services 54.7p 54.5e / Composite 54.1p 53.9 e
• 0400 am ECB Sep M3 (y/y) 3.5%p 3.5%e / private loans 3.1%p 3.2%e
• 0540 am German 5Y Bobl sale
• 0900 am US Aug FHA housing price index (m/m) 0.2%p
• 0945 am US Oct flash Manufacturing PMI 55.6p 55.4e / Service 53.5p 54e / Composite 53.9p 53.8e
• 1000 am US Sep new home sales (m/m) 3.5%p -0.8%e / 0.629mn  p 0.625mn e
• 1000 am Bank of Canada rate decision – 25bps hike to 1.75% expected
• 1030 am US weekly EIA crude inventories 6.49mb p 1.9mb e
• 1115 am BOC press conference
• 1130 am St. Louis Fed Bullard speech
• 0100 pm US Treasury sells 5Y notes
• 0200 pm US Fed Beige Book
• 0200 pm Atlanta Fed Bostic speech

Thursday, October 25: German IFO, ECB rate decision, US pending home sales, durable goods.

• 0545 pm NZ Sep trade deficit (m/m) NZ$1.48bn p (y/y) NZ$4.81bn p
• 0700 pm Korea 3Q GDP (q/q) 0.6%p 1%e (y/y) 2.8%p 2.7%e
• 0200 am German Nov GfK consumer confidence 10.6p 10.5e
• 0300 am Spanish 3Q unemployment survey 15.3%p 14.9%e
• 0400 am German Oct IFO business climate 103.7p 103.1e / Current 106.4p 106.0e / Outlook 101p 100.3e
• 0745 am ECB rate decision – no change expected, details on tapering QE possible
• 0830 am ECB Draghi press conference
• 0830 am US weekly jobless claims 210k p 213k e
• 0830 am US Sep wholesale inventories (m/m) 1%p 0.5%e
• 0830 am US Sep goods trade deficit $75.8bn p $74.9bn e
• 0830 am US Sep durable goods orders (m/m) 4.5%p -1.3%e / ex trans 0.1%p 0.3%e
• 1000 am US Sep pending home sales (m/m) -1.8%p -0.1%e
• 0100 pm US Treasury sells 7Y notes
• 0700 pm Cleveland Fed Mester speech

Friday, October 26: Tokyo CPI, US 3Q GDP, ECB Draghi, University of Michigan Cons. Sentiment

• 0730 pm Japan Oct Tokyo core CPI (y/y) 1%p 0.9%e / core-core 0.7%p / headline 1.3%p
• 0245 am French Sep PPI (m/m) 0.2%p 0.2%e
• 0245 am French Oct Consumer Confidence 94p 94e
• 0600 am UK Oct CBI retail trade survey 23%p
• 0630 am Russia central bank rate decision – no change from 7.5% expected.
• 0830 am US 3Q preliminary GDP 4.2%p 3.3%e / PCE prices 2%p 2%e
• 1000 am US Oct final Michigan Consumer Sentiment 100.1p 99e
• 1000 am ECB Draghi Speech
• 1015 am ECB Coure Speech
• 1100 am Canada Aug budget balance C$0.14bn p –C$0.97bn e

Conclusions: Its growth that matters?  

The debate about financial conditions and the Fed is likely going to continue.The reaction function of the FOMC to global market volatility particularly in the EM world didn’t seem to matter much according to last week’s minutes.

The rise up in the USD last week tracking the higher rate hike expectations returns markets to old correlation ideas. Higher rates won’t hurt risk until they are restrictive and that shows up in financial conditions. The forward-looking growth in the US as shown from the Conference Board leading indicators (4.3% from 4.2%) suggest no issues into 2019. The Philadelphia Fed Manufacturing index at 22.2 from 22.9 is well over the 19.7 expected and the 19 3-month average. Perhaps even more compelling is that future expectations are even higher at 33.8.

Growth in the US in 3Q is expected at 3.3% and this should hold into 4Q unless something surprises – either trade wars or US mid-terms. There are some other worries in the economy as well – housing which saw existing home sales drop to near 3-year lows.Some blame higher rates, others lack of inventory, both arguments reflect a cycle that is waning. The issues for rate sensitive shares seems obvious into December.

The bottom line for next week will be in the USD which remains the barometer for the US FOMC tightening mattering to the rest of the world. Whether this USD can break out of the 95-96 flag formation will set up for the next 2-3% more and the risks for knock-on financial conditions effects are clear.