For central banks in 2019, the catchword is caution
- Tai Hui says now more than at any time in the past few years, central bankers will need to scrutinise and respond closely to evolving economic data, and be aware that any miscommunication could adversely affect economic growth
The world’s major central banks have been running on autopilot for the past few years. Global economic growth has been steady despite rising US-China trade tensions, rising populism in Europe and turmoil in some emerging markets.
The US Federal Reserve has raised its policy rate four times in 2018, by a total of 1 percentage point, to 2.25-2.5 per cent. The European Central Bank is ending its quantitative easing at the end of the year. The Bank of Japan is keeping to its course of asset purchases, given that its inflation target remains elusive. However, these predictable paths are set to change in 2019, potentially making an impact on global financial assets.
Starting with the US, economic fundamentals still look good. The labour market boasts the lowest unemployment rate in decades and job growth is still robust. This, alongside a healthy household balance sheet, is boosting consumption.
In fact, with the economy running at full capacity, the risk is for inflation to rise in the near term. However, the core personal consumption expenditure deflator – the Fed’s preferred measure of inflation – is still below target.
Meanwhile, market signals have become gloomier. The S&P 500 has fallen by 10 per cent since early October. The difference between the yields for two-year and 10-year US government bonds, a reliable gauge of market sentiment about the risk of a recession, has fallen to just 0.15 per cent. Investors are worried that this indicator is predicting much tougher times ahead.
The Fed needs to take note of both economic and financial indicators, which are telling opposite stories. This is perhaps why the Fed’s chairman, Jerome Powell, made a notable change in his view on where the policy rate is now.
In October, he saw the Fed’s policy rate to be “a long way from neutral”, which suggested the central bank could still raise interest rates a few more times in the coming quarters. Following the December Federal Open Market Committee meeting this week, however, he said the policy rate was now at “the lower end of neutral”. This implies that the US policy rate could peak soon, and the path of future rises is likely to be even more gradual.
I still believe the risk of recession in the US remains low, and hence we could see another two 0.25 per cent rate hikes in the first half of 2019. By then, the policy rate would be at 2.75-3 per cent, which is the Fed’s projection of where the long-term policy rate should be. This implies that the pace of interest rate increases could be less regular and even more dependent on economic data and market volatility in 2019.
This would also imply that interest rates in Hong Kong could rise at a slower pace. This may provide some relief to the property market, but would leave cash deposits as an unattractive investment option.
In Europe, the European Central Bank is still pencilling in a policy rate rise in late 2019. This is ambitious, given that Europe’s growth momentum has eased in recent months. The risk of a recession in Italy has risen. Brexit is largely a UK event, but its potential to spill over to Europe is still unknown.
The political climate in Germany and France has also become much more challenging and could dampen business confidence. Compared to the US, the ECB has no bullet in the gun to deal with the next recession. This implies government spending and fiscal policy could be the only way to support growth.
In Asia, the Bank of Japan is most likely to maintain its asset purchases, making it the only central bank in the world that is still engaging in quantitative easing. Its 2 per cent inflation target is undermined by Japan’s weak consumption.
China is expected to follow a more relaxed monetary policy to revive growth momentum. However, China’s magnitude of easing could be limited by the desire to maintain currency stability and the central bank’s wariness of another debt-fuelled boom.
Next year, central bankers will need to roll up their sleeves to scrutinise economic data even more closely as we proceed deeper into the late cycle, and communicate their intentions clearly to the market. Misguided policies, such as tightening too aggressively, could put economic growth at risk. Meanwhile, a failure to communicate would run the risk of exacerbating market volatility.
Tai Hui is chief market strategist, Asia-Pacific, at JP Morgan Asset Management