8 to 14 July: Central banks across the globe await the Fed’s green light

We covered the Federal Reserve’s policy U-turn extensively during the previous weeks: a 25bp rate cut and pausing the balance sheet run-off at the end of July seem like a done deal. Now, it is time to look around what other central banks across the globe could do. In general, central banks operating in a benign inflationary environment and in economies that are not too susceptible to external shocks may find room for policy manoeuvre to ease financial conditions in the coming months either by outright slashing their policy rates and/or by injecting additional liquidity into their domestic money markets (e.g. Indonesia, the Philippines, Brazil, Chile, Peru, South Africa, Egypt, etc.). As a result, emerging economies will enjoy the benefits of (increasingly) accommodative monetary stances and will exhibit stronger domestic economic activity.

1 to 7 July: Reality check: it’s time for the market to take the chill pill

The broad market was getting ready to enjoy the refreshing effects of a massive liquidity wave by the Federal Reserve up until the jobs report was released on Friday afternoon. According to the pricing implied by the Fed funds future, the broad market foresaw a cumulative 100bp worth of rate cuts over the course of the next 12 months, and even toyed with the thought of a greater-than-25bp rate cut in July. The actual June US (un)employment numbers, however, were at odds with the market’s overly bearish expectation. Our longstanding view was confirmed that the domestic consumption-led growth story in the US would last and serve as one of the most important growth engines this year. We maintain our view that real GDP growth in the US is not going to meaningfully slow below trend growth (if at all) over the course of the coming quarters.

In the aftermath of the jobs report release, the market has started to recalibrate its expectations for the Fed funds rate. On Monday morning, the pricing implied a 25bp cut with very high certainty in July and 50bp additional easing for the next 6-9 months. In conclusion: a release of liquidity vis-à-vis Fed funds rate cut could give the broad market a sugar rush in the short-term but would not have a long-lasting positive effect. We are of the view that strong economic growth is without question better news for the world economy than ‘lower for longer’ interest rates.

24 to 30 June: As good as it gets

It seems that Presidents Trump and Xi has had a relatively fruitful discussion, as the two leaders did not resort to further raising tariffs or other punitive measures against each other. This might not seem too meaningful at first sight, but compared to the alternative scenario, in which talks break down and additional confidence damaging measures are taken, this outcome is definitely promising. There are, however, further issues to tackle, which are not going to be fast (such as intellectual property issues, Huawei, etc.)

Based on the looks of the market moves this morning, the broad market is happy(-ish) with the way things have turned out. These pieces of news were just enough the calm some of the nerves for now. If the talks between US and China remain constructive, then global investor sentiment could persistently improve and translate into stronger appetite for risk assets.

17 to 23 June: Central banks are ready to step up, again

Two major central banks – the Federal Reserve (Fed) and the European Central Bank (ECB) – sent very strong signals during the week that both stand ready to slash interest rates and pump liquidity to address the prevailing market and economic strains. Although the Fed and the ECB could opt for the same resolution (i.e. loosening financial conditions), the two will do so for very different reasons: the Fed needs to provide comfort to market players globally in the context of slowing growth and international trade tensions, whilst the ECB needs to address the Eurozone’s structural deficiencies with tools that can only manage cyclical woes. Meanwhile, the Bank of Japan has not even had the chance to consider the reversal of its ultra-accommodative stance. Therefore, we are stuck in an era of #QEinfinity, where central banks (need to) step up, while governments stay on the side lines instead of delivering structural reforms.

What does this mean in the world of emerging markets if the Fed (and the ECB) deliver dovish measures? Simply put, central banks in emerging countries will have greater flexibility to opt for more accommodative policies, which in turn will prop up economic growth and support asset prices.

10 to 16 June: Benign inflation puts fuel to the fire for the Fed to cut the interest rate

Inflation in the US was 1.8% YoY in May, coming in below the consensus forecasts. Consumer price inflation slowed from the 2% pace recorded in April, which coincided with the Federal Reserve’s 2% inflation target. In addition, in core CPI inflation (a gauge that excludes volatile prices, such as fuel, etc.) also slowed to 2% YoY. Benign inflation combined with slowing growth and escalating trade tensions could increase pressure on the Federal Reserve to bow to the market and cut interest rates this year. The market now takes it for granted that the Jerome Powell-led FOMC will slash the Fed funds futures by 25bp by the end of July and initiate an easing cycle. Fed policymakers meet this week, where a rate cut is not expected just yet, but the post-meeting communication will be one of the most scrutinised events this year.

3 to 9 June: President Trump might just get his coveted rate cut soon

It very much looks like the market has made up its mind that the Fed funds rate will be reduced by 25bp at the end of July. The broad market came to this conclusion after a series of weaker-than-expected macro data releases. In our view, macro data in the US continue to signal solid growth ahead, which would not call for easing by the Fed in normal times. However, we do not live in normal times, as we live in an era, where the US President’s approach to economic policymaking disrupts global business and investor sentiment. If such deep concerns are left unaddressed by prudent policymakers (i.e. the Federal Reserve), they can easily become a self-fulfilling prophecy and lead to a downturn in economic activity. Consequently, both the Fed and the market will need to just Powell through (please, excuse the pun).

27 May to 2 June: The Tariff Man strikes again

During the last few weeks, we pointed out that the chances of a cease fire between the US and China had become unlikely on the foreseeable horizon. As US President Trump upped the ante last week and slapped a considerable amount of tariffs on Mexican exports to the US, the probability of a near-term global trade truce has decreased even further. The POTUS’ measure caught markets off-guard and triggered massive safe haven flows driving the 10-year US Treasury yield to 2.13% – a low not seen since September 2017. The reason for such a swing in the global investor sentiment is simple: it has become obvious that any country can easily become a target in just a blink of an eye, as President Trump imposed punitive tariffs on Mexico purely for domestic political gains (i.e. not for reasons underpinned by economic ideology). Such policy unpredictability can easily disrupt market sentiment for a protracted period of time.

Thus far, we argued that the global growth story would not be meaningfully hurt by the US-Sino trade dispute. Since the outlook for global trade was contorted, we had to revise our view regarding the impact of the trade tensions on global growth. Countries like Mexico with open economies, weak structural growth potential and very limited room for policy stimulus will face dampening growth prospects. On the other hand, countries relying primarily on domestic structural growth with largely closed economies and policy space to stimulate, such as China, India and Brazil, will go through this episode with greater ease than what the broad market currently prices.

20 to 26 May: The spat goes on: “It is not me, it is you”

The US and China were pointing fingers at each other last week claiming that their partner acted unreasonably and hindered making progress in the negotiations. On Monday, US President Trump came out with a statement citing that he and his administration were not ready to make a deal with China, threatened that tariffs can go up ‘could go up very, very substantially, very easily’ and added that eventually there would be a trade deal in the future. In a nutshell, there is really nothing new here that could meaningfully impact macroeconomic fundamentals. We remain of the view that global investor sentiment will swing according to the headlines related to the trade negotiations. For the time being, investors should find comfort in the fact that Chinese authorities publicly – including the PBOC – claimed that any disruptions to the renminbi market will be prevented to keep the market stable, and that the Fed remains patient.

13 to 19 May: Will the quarrel ever end?

Last week we pointed out that global investor sentiment deteriorated because of the escalating trade tensions between the US and China, despite the release of encouraging macroeconomic data from the US and China. During the week, risk aversion further intensified as the world’s two largest economies continued to play ‘tit-for-tat.’ As tensions further escalated, several media outlets sounded the alarm that China could off-load a vast amount of US Treasuries to push back against an increasingly impatient President Trump. We are of the view that China will not resort to the nuclear option, because it would have severe repercussions for China itself too. In addition, it would be highly impractical, as China would not find easily any other market with such size and depth. There is a bright side though, which remains underappreciated by the market: the Fed and the PBOC have a pretty good excuse now to maintain accommodative financial conditions in an environment where inflation remains benign and GDP growth decent. In our view, the market will just need find solace in the fact that the overwatch of central banks will stand pat to aid economic growth and floor asset prices, as the chance for extending the olive branch is quite slim anytime soon.

6 to 12 May: Renewed trade tensions poison the well

Talks between the US and China ended without a resolution last week. Trade tensions escalated further, as the US administration raised tariffs to 25% on USD 200bn worth of Chinese exports to the US. Following the move, China has vowed retaliation. The anxious reaction by the broad market reflects the fact investors have started to re-assess whether a deal between the two countries is possible in the near term. Although global investor sentiment turned sour, in our view the macroeconomic fundamentals of the US and China will not be meaningfully hurt by the prolonged trade discussions. For the time being, the market is likely to ignore macroeconomic fundamentals and will probably focus on headlines related to the trade discussion between the two countries. Protracted trade tensions will continue to weigh on global market sentiment until the two parties clearly signal a step forward towards a consensus.