Markets wager on Fed rate cut as slowdown fears swell

Global markets were on the edge on Friday as dire US economic data slammed Wall Street and pushed investors to bet the Federal Reserve could reverse its policy tightening before the end of this year.

US stock futures slipped in early Asian trade with E-Minis for the S&P 500 off 0.3 per cent.

Japan's Nikkei spiralled about 3.6 per cent lower, led by a spike in the yen. Australian shares skidded over 1 per cent, dragging MSCI's index of Asia-Pacific shares outside Japan 0.2 per cent lower to near two-month lows.

Fears the Sino-US trade battle would drag down world growth roiled risk-sensitive assets in 2018, driving a surge in volatility and sending major stock markets deep into the red.

Those worries found some basis this week with Thursday's disappointing survey data from the Institute for Supply Management (ISM) showing US factory activity slowed more than expected in December.

That followed Apple Inc's announcement on Wednesday that it had cut its revenue forecast for the first time in nearly 12 years, blaming weaker iPhone sales in China. The shares crashed nearly 10 per cent overnight.

The dismal ISM report drove investors to the safety of bonds. Yields on the two-year Treasuries sank below 2.4 per cent to reach parity with the federal funds effective rate for the first time since 2008.

Three- and five-year yields were even lower, an inversion that has sometimes heralded recessions in the past. Yields on 10-year benchmark paper dropped to 2.55 per cent, a staggering turnaround from the highs of 3.25 per cent seen as recently as November.

The falls kept the dollar on the defensive. The green-back plumbed a more than nine-month low of 105.25 against the safe-haven yen on Thursday, driven by technical factors amid thin holiday trade.

It has fallen more than 2 per cent so far this week, the biggest weekly loss since last February, and was last at 107.675.

“The ISM manufacturing index tumbled more than five points. A drop of this magnitude has only been seen four times since 1980, three of which the economy was in the midst of recession,” said Michelle Girard, US economist at RBS.

“The ISM has a long track-record and big moves often prove to be meaningful. The December drop therefore gives pause, even to us economic optimists. Now, a closely-watched indicator is flashing yellow, putting ourselves, and likely the US Federal Reserve, on higher alert,” Girard added

Investors had expected the Fed to stay on its tightening path after three hikes last year, but the ongoing trade war and recent disappointing corporate earnings have put those expectations to rest.

The December Fed funds contract imply a cash rate of 2.23 per cent, below the current 2.25-2.50 percent and expectations of 3 percent just a couple of months ago.

Investors see rates at 2.00-2.25 per cent by April next year.

“Markets have sharply re-priced the outlook for the Fed with a rate cut 50 percent priced by December 2019 and fully priced by April 2020,” said Tapas Strickland, markets strategist for National Australia Bank.

“Whether this pessimism continues for the rest of 2019 will largely depend on whether there is a near-term resolution to the trade war,” Strickland added.

Concerns about a US recession whacked Wall Street overnight, with the Dow skidding 2.8 per cent, the S&P 500 down 2.5 per cent and Nasdaq losing more than 3 percent.

MSCI's gauge of stocks across the globe shed 1.4 per cent on Thursday.

Keeping with the risk-off theme, gold prices hit a 6-1/2-month peak of $1.294.88 an ounce.

Oil was on a slippery slope, with US light crude off 42 cents at $46.67 a barrel but slightly above a 1-1/2 year trough of $42.36 touched just last month.