Federal Reserve rates, China’s balancing act and Europe’s sluggishness all point to the global growth scare getting scarier in 2019
- Nicholas Spiro says investors may have been heartened by recent news from Italy, the Fed and the trade truce, but US interest rates will keep rising unless the economy shows signs of slowing, and the overall outlook for Europe is gloomy
While it does not feel like it, the past fortnight has been kind to financial markets. A confluence of developments – comments by leading policymakers at the US Federal Reserve, which fuelled speculation that the pace of monetary tightening will slow next year, a temporary ceasefire in the US-China trade war and signs that Italy’s populist government is backing down in its fiscal battle with the European Commission – have put an end to the fierce, broad-based selling pressure that began in early October.
Since November 23, the MSCI Emerging Markets Index – a leading gauge of stocks in developing economies – has risen more than 3 per cent. Spreads on US corporate bonds, which widened sharply in October and in the first-half of November, have narrowed, helped by a tentative recovery in oil prices. What is more, the yuan has edged back from the psychologically important level of 7 versus the US dollar, increasing 1.8 per cent on Monday and Tuesday, its strongest two-day gain since July 2005.
Yet, to say that sentiment remains fragile would be an understatement. Just hours after Asian equity markets began rallying on Monday morning in response to the easing of trade tensions, the publication of a slew of weak data on manufacturing activity across the globe revealed the severity of a slowdown that is becoming the focal point of market anxiety.
A Purchasing Managers’ Index (PMI) survey produced by JPMorgan and IHS Markit showed that global manufacturing output last month remained at its weakest level in nearly two years. New export orders in emerging markets fell for the eighth straight month, mainly due to persistent declines in China, where manufacturing output is on the verge of contracting.
In the euro zone, manufacturing activity has collapsed this year after expanding at its fastest pace in two decades last December. The PMI survey for the bloc revealed that factory output last month fell to its weakest level since August 2016, with growth in Germany, Europe’s largest economy, dropping to a 2½-year low. IHS Markit notes that the downturn is “linked to trade wars [and] intensifying political uncertainty” in Europe. More ominously, it points out that business confidence in the euro zone has not been this gloomy since the sovereign debt crisis in 2012.
Yet it is the alarming prospect of a US economic slowdown that is the focus of attention right now, mainly because the United States has been the driver of global growth this year, with its economy expanding close to 4 per cent year-on-year in the last two quarters, the fastest back-to-back pace since 2014.
On Monday, a segment of the US bond yield curve – which reflects the difference between shorter- and longer-term interest rates – inverted for the first time since 2007. An inversion of the yield curve is widely regarded as a prelude to a recession. While the risk of a sharp downturn in America, which is enjoying record low unemployment and buoyant consumption, in the coming quarters is remote, bond markets are anticipating a marked slowdown.
A more cautious tone from the Fed has led investors to significantly scale back their expectations for interest rate hikes next year. Traders believe the central bank will be forced to halt its rate-hiking cycle as early as the end of 2019 and start cutting rates in 2020 as the economy slows. Yet the Fed’s own forecasts suggest rates will keep rising during this period. The fear that US monetary policy has become too tight is fuelling concerns about growth, heightened by mounting scepticism over the US-China trade ceasefire. On Tuesday, the S&P 500 equity index suffered one of its sharpest daily declines in recent years as a global growth scare took hold.
Worries about growth are only likely to intensify as 2019 gets under way. While the Fed may well turn more cautious next year, its policies are data-dependent. If America continues to expand at a solid clip, and wages rise more quickly, the Fed will keep increasing rates at a gradual pace. As I argued in a previous column, an early end to the rate-hiking cycle would make investors even more concerned about a slowdown in the US economy.
Yet, such fears would pale in comparison with the stress in markets that could ensue from the European Central Bank’s momentous decision later this month to end its quantitative easing programme, despite clear evidence that growth and inflation in the euro zone are slowing. The Fed has managed to tighten policy without triggering a major crisis. It is not clear whether the ECB will be as fortunate, especially given the problems in Italy.
Then there is the bigger threat of a sharper slowdown in China, made more acute by Beijing’s increasingly incompatible policy goals and the near certainty that the trade conflict will rumble on.
This week showed that October’s sell-off has morphed into a growth scare. The betting is that this is a foretaste of what lies ahead for markets in 2019.
Nicholas Spiro is a partner at Lauressa Advisory