Despite the turmoil, the global
economy will continue to grow with low inflation in 2019
2018 has been a year of
turmoil for financial markets with weakness in the bond markets and two
significant sell-offs in equity markets. However, 2019 promises to be much
calmer. After a very strong start in equity markets between November 2017 and
the end of January 2018, there was a big sell-off from January to April, and
another beginning in October and continuing through to December. In between
there was a series of disturbances in emerging markets (EM) featuring crises in
Venezuela, Argentina and Turkey. In addition to the long-running saga of the
Brexit negotiations, the year featured a strong rise in the price of oil
followed by a sudden collapse from early October, and disruptions created by
President Trump’s repeated trade measures – targeted first at steel and
aluminium, then at Europe and NAFTA (North America Free Trade Agreement), and
ultimately focusing primarily on China. With numerous other geopolitical events
adding to investors’ anxieties – such as wars and unrest in the Middle East,
continuing immigration pressures in Europe and the US, the victory of populists
over the establishment in Italy and the consequent budget disputes with the EU
Commission in Brussels – there was plenty of reason for investors to pull back
from risk-markets such as equities. However, the fundamental backdrop to all
this was the US Federal Reserve’s (Fed) policy of normalising US interest
rates, raising them from 1.25% in early December 2017 to 2.25% a year later,
and shrinking it balance sheet. Rising US rates always create a challenging
environment for investors. After nearly a decade of virtually zero interest
rates, the upturn in rates has put steadily increasing pressure on equity and
other risk asset classes. Although some of these geopolitical events may prove
to be temporarily damaging, it is my view that they will prove to be no more
than waves on the surface of the tide which is the record-breaking expansion of
the US business cycle. (Greenwood, 2019)
US monetary policy is becoming less
accommodative, but the Fed is not “tightening”, only “normalising” policy. The
current “normalisation” phase is analogous to the mid-course corrections in
interest rates that occurred in 1994-95 and 2004-05. The important point about
those episodes was that the business cycle continued to expand for several
years after the completion of normalisation, and the equity and real estate
markets also peaked considerably after these rate hikes were completed. At its
meeting on 7-8 November the Federal Open Market Committee (FOMC) of the Fed
kept the federal funds rate at 2.0-2.25%, having removed in September the
wording in their previous statements that had asserted the “stance of monetary
policy remains accommodative”. The median projection of FOMC members for the
federal funds rate remained at 3.1% for 2019 (suggesting four rate hikes of
0.25% during 2019) and 3.4% for 2020, but with the recent sell-off on Wall
Street and the plunge in the price of WTI oil to $51 the FOMC may defer raising
rates at their meeting on 18-19 December.
Bibliography
Greenwood, J. (2019). Annual Economic Outlook 2019.
Invesco.
