18 to 24 February: “Risks and uncertainties” – FOMC minutes reiterate a patient approach

The Federal Open Market Committee (FOMC) released the minutes from their January meeting. There was a mutual agreement for the FOMC to end the shrinkage of the USD 4tn balance sheet by the end of the year. Members are keen to let the effects of previous tightening play out in the economy but there were concerns that Brexit, Europe and China could weaken domestic growth in the US. The minutes showed that ‘many’ members on the committee were unsure whether any rate adjustments would be needed, with participants advocating a patient approach to future policy action.

The message delivered by FOMC members through the minutes is in line with our base case that the Fed is going to be very cautious to avoid committing a policy mistake. In our view, the Fed’s cautious approach gives impetus to EM asset prices when risk appetite is healthy and could serve as a floor, in times of risk-off global market sentiment.

11 to 17 February: Markets’ focus may shift to Fed policymakers this week

Although the global economic diary does not contain too many relevant datapoints for this week, financial markets will probably not be bored, as the Federal Reserve will provide more than enough information to digest. Those investors, who seek clarity on the Fed’s monetary policy (especially on the balance sheet run-off), will probably be happy to read the FOMC minutes from January on Wednesday. Furthermore, between Tuesday and Friday, there will be a plethora of speeches by Fed policymakers, who are expected to provide guidance on the how members of the FOMC think. Amongst many others, investors want to hear answers to questions, such as the terminal size of the Fed’s balance sheet, the asset mix (Treasuries vs. MBSs) and duration. Should the prevailing information be of dovish nature, appetite for risk assets could further strengthen, most likely translating into EM asset price gains.

4 to 10 February: Should concerns about global growth be taken seriously?

Bond yields slipped to very depressed levels once again marking that financial markets remain concerned about the state of the global economy. The question arises whether the worries of the fixed income universe is justified and what one should expect in terms of economic activity going forward. In the US, GDP growth is likely to slow throughout 2019, which – in our view – means normalisation from a previously overheated pace. As the Chinese structural growth story seems to be unhurt thus far, the current slowdown in China is of cyclical nature, which has been already addressed by the local authorities. In the rest of the EM space, apart from some idiosyncratic developments (such as Argentina, Turkey, etc.), most of the economies are likely to deliver good enough performances. We see the Eurozone, as one of the outliers, since economic activity in the Zone has been stuttering in 2H18, while monetary stimulus is being withdrawn and no meaningful fiscal support has been deployed – deepening the worries of an impending recession. Therefore, we are of the view that the probability of a global economic stagnation or recession is very low on the 12-18-month horizon.

28 January to 3 February: How long could Goldilocks stay, while the bears are away?

Markets breathed a sigh of relief after Fed Chair Powell’s remarks on Wednesday. Mr. Powell delivered a speech, which signified a policy U-turn compared to his thoughts presented in December. The Fed Chair not only claimed that the FOMC is ready to pause its rate hiking cycle, but he also stated that the Committee ‘will not hesitate to make changes [to the process of balance sheet normalisation] in light of economic and financial developments.’ This was the first time that Mr. Powell publicly and openly talked about the possibility of pausing the run-off of the central bank’s balance sheet – should the environment call for it. We argued on many occasions in our weekly GMUs last year that the Fed’s balance sheet normalisation policy is one of the key structural drivers of global capital markets and asset prices. The market’s rally in response to the Fed Chair’s remarks proves that our assumption was right.

So, what’s next? Are the bears gone and is Goldilocks back in the game? Probably, yes, as the Fed has become ‘patient’ in an environment where inflation remains muted, the headlines from the US-China trade talks sound increasingly more constructive and Chinese authorities have been delivering stimulus measures to boost the world’s second largest economy’s domestic drivers. These factors may allow investors to bask in the sunlight that finally radiates through clouds. Consequently, we are of the view that emerging markets have the chance of performing well in the coming months, as risks are being persistently priced out. Should further risks dissipate (such as Brexit, a potential recession in the Euro Area, scrapping the tariffs between the US and China, etc.), the prevailing asset price momentum could be sustained on a longer-term horizon – but these are stories for later.

21 to 27 January: Is a rebound of economic growth on the horizon?

The IMF presented its updated global macroeconomic outlook, in which the organisation admitted that their previous GDP growth forecast for 2019 and 2020 was too optimistic. As a result, they revised down the forecast for global growth to 3.5% and 3.6% in 2019 and 2020, respectively. Within the developed world, Germany’s growth prospects deteriorated to the greatest degree (-0.6ppt to 1.3% in 2019), while the US’s outlook remained unchanged at a solid pace (2.5% in 2019). Within the emerging universe, the GDP growth estimates for China (6.2%), India (7.5%) and Brazil (2.5%) were broadly unchanged for this year.

Although the IMF – again – fell behind the proverbial curve in terms of forecasting, the fact that the global economy has been slowing should be no surprise to investors, as both soft and hard indicators have been signalling the direction of travel. A significant degree of economic slowdown has already been priced into financial asset throughout 2H18, probably more than fundamentally warranted. We are of the view that the extent of the slowdown is over-discounted by markets, partly due to the prevalent political noises globally (e.g. trade tensions, Brexit, the partial government shutdown in the US, etc.). The spurring effect of the Fed’s ‘patient’ stance and the stimulus measures taken by the Chinese authorities will certainly materialise, the only question whether it materialises sooner or later.

14 to 20 January: Political risks take the driving seat, again

Various risks of political nature linger that drive global market sentiment and thus asset prices. Just to name a few:

• Due to the government shutdown in the US, markets are losing visibility on the outlook for US rates and yields, since the publication of relevant macroeconomic data is delayed (such as retail sales last week).
• No new meaningful pieces of information may be revealed related to the ongoing trade talks between the US and China in the short-term.
• Nobody knows for sure how to capture the magnitude of Brexit’s economic implications or when Brexit may materialise.
• Populist parties could upset the frail political landscape within the EU after the elections are over.

Whilst it is difficult to accurately incorporate political risks in asset prices, the uncertainty and unpredictability will sooner or later translate into higher volatility.

7 to 13 January: The Powell put and trade talks improved the markets’ risk appetite

“The principal worry I would have is really global growth,” said Fed Chair Jerome Powell. The Fed Chair added that the FOMC will be “patient” and “flexible” when it comes to the degree and pace of monetary tightening. Although no tangible pieces of information were released after the talks between the US and China were concluded last week, it was just enough for markets that the two countries released coordinated statements that talks were productive and may continue very soon. The combination of these two factors improved global market sentiment and strengthened the appetite for risk. Should the macroeconomic data from the US and China be convincingly solid this week, upbeat investor sentiment might just be sustained for more than just a couple of days.

Financial markets will need to digest a whole bunch of macroeconomic data coming from the US, again, such as PPI inflation, new home sales, factory orders, retail sales, industrial production and the sentiment index produced by the University of Michigan. Meanwhile, on the other side of the Atlantic, both the UK and the Eurozone are going to reveal consumer price inflation figures from December.

Within the emerging Asian space, markets are going to focus mainly on Chinese foreign trade data, Indian consumer price inflation and the rate setting meeting in Indonesia. In Latin America, various high-frequency macroeconomic indicators will be released, such as the November economic activity indicators from Peru and Brazil. African markets face a light economic diary this week, as no major released are scheduled apart from monetary policy decision in South Africa, Nigerian consumer price inflation and Egyptian foreign trade statistics.

31 December to 7 January: The US’ economic outlook is not as bad as markets deem

 Although the holiday season usually implies boredom, this was definitely not the case last week, when asset prices exhibited excessive moves – especially in the developed market universe. Market players in the US have been focusing so much on the negative side of data releases and political noise that not only was stock market performance impaired, but rate hike expectations turned upside-down and transformed into rate cut expectations for the middle of 2020. As opposed to the implied stagnation of earnings for 2019 by some of the major indices (such as the S&P 500), we are of the view that the currently available soft and hard economic indicators do not imply a recession in the US throughout 2019 – only a slowdown. A slowdown should not come as a surprise to anyone, as it has been long known that the tailwinds by President Trump’s tax cuts would abate, while the monetary stimulus by the Fed would be continuously withdrawn. Furthermore, even the combined effect of trade talks between the US and China and the government shutdown in the US is not enough to trigger a recession in the world’s largest economy. We reiterate our view that the US’s economy will continue grow this year, which in turn will allow the Fed to carry on with the tightening cycle.

Although the monthly US jobs report is behind us, the calendar is stuffed with relevant data releases. Namely: the market will likely closely gauge the ISM non-manufacturing index from December and will also eagerly scrutinise the minutes from the Fed’s last monetary policy meeting. Furthermore, Fed Chair Powell gives a speech on Thursday, while the December CPI inflation measure will be revealed on Friday. The economic diary is lighter in Europe, where the Eurozone retail sales figure and the UK monthly industrial production and GDP statistics are scheduled.

Within the emerging universe, Asian markets will mainly focus on Chinese CPI and PPI inflation from December. In addition, a delegation from the US visits Chinese policymakers to continue trade talks. Meanwhile, within the Latin America space, CPI inflation data will be published in Chile, Mexico, Argentina and Brazil, while the Peruvian central bank decides on the policy rate. African markets will monitor the latest PMI and manufacturing data from South Africa and inflation from Egypt.

10 to 16 December: Is a recession really in sight?

Markets have been bracing for a recession in the US , and as a result investors have been increasingly selling risk assets. The US Treasury curve has already semi-inverted, as the 2- to 5-year segment flattened, while the 10-year remains barely above the shorter maturities. Both stock and bond markets can be good indicators of future recessions, however, they can also give false signals. Paul Samuelson, a Nobel laurate economist famously quipped that ‘The stock market has called nine of the last five recessions.’ implying that stock markets can be overly bearish from time to time and signal incoming recessions at inappropriate times. We acknowledge the downside risks to the current economic cycle posed by the trade war and the tightening cycle of the Fed, and in addition, we recognise that this is one of the longest-running business cycles in modern economic history. Despite the aforementioned facts, we remain of the view that the US economy is unlikely to slip into a recession over the next 12-18 months, with our base case being a moderate slowdown of GDP growth.

The economic diary for the week ahead is loaded with relevant policy events and macroeconomic data releases. For obvious reasons, the Fed’s monetary policy decision, updated macroeconomic projection, adjusted dot plot and Chair Powell’s press conference are going to be in the limelight. Furthermore, the US authorities release the third print of the Q3 GDP data, and publish the November PCE inflation figure, i.e. the Fed’s preferred inflation gauge. On the other side of the Atlantic, the Bank of England is expected to keep the policy rate stable in the UK.

Within the EM universe, markets will need to digest several central bank decisions. Asian markets will primarily focus on the Indonesia and Taiwanese central banks’ monetary policy decision. In addition, Chinese President Xi gives a speech in which he might signal how the trade discussion between the US and China develops. Latin American investors will focus on the Q3 Argentine GDP release followed by the rate-setting meetings of the Mexican and Colombian monetary authorities. In Africa, the Moroccan central bank will deliver its policy decision.

3 to 9 December: It’s the economy, stupid!

Sovereign yields sank to alarmingly low levels on both sides of the Atlantic by the end of the week. In addition, the US Treasury curve produced a very unusual shape during the week, i.e. the 5-year yield slipped below 2-year tenor, while the 10-year remains above both – although barely. The question arises: why are yields so depressed, especially when the Fed has been tightening and the ECB is laying the groundwork to start tightening? To answer this question, we quote Bill Clinton’s famous Presidential campaign slogan ‘It’s the economy, stupid!’ from 1992, as it remains valid today. It is, indeed, the current state of the economy and its outlook for growth that weighs on sentiment in financial markets. In the Eurozone, market participants may believe that the European Central Bank’s claim to exit from its ultra-loose monetary policy stance is just not credible, due to the meagre economic growth and the absence of domestic price pressures. Meanwhile, US markets may be distressed by trade war-related concerns that could hurt the profitability of US corporates. Therefore, there is a key difference between what causes European and US markets to stir: the Euro Area continues to face inherent structural deficiencies that are not being addressed due to seemingly irresolvable internal political tensions, while sentiment in the US is curbed by fears induced by trade tensions. This leads us to conclude that divergence in terms of monetary policies, economic and market performances between the Euro Area and the US may continue next year – especially if volatility brought about by trade wars dissipate.

During the week ahead, the US is going to release CPI inflation and retail sales figures from November and the Markit manufacturing PMI number for December. Although the releases will not influence short-term interest rate expectations, since the Fed’s – expected – rate hike in December is a done deal, all three indicators should give guidance to financial markets on where the Fed funds rate could peak next year. The Eurozone will also release CPI inflation and PMIs next week, but most importantly, the European Central Bank will deliver the last monetary policy decision this year, including the announcement of the asset purchase programme’s termination at the very end of December.

Within the EM universe, various Asian countries are going to reveal a set of relevant macroeconomic indicators, such as CPI inflation in India, money supply, retail sales and industrial production in China, while the Philippine central bank decides on the policy rate. Latin American markets will focus on high-frequency macroeconomic data in Mexico, Colombia and Brazil (e.g. industrial production, retail sales, etc.). In addition, the Peruvian central bank announces its decision on the policy rate. Meanwhile, within the African space, Q3 GDP data will be published by Morocco, Kenya and Nigeria.