Reflecting on 2018, global markets have tilted from optimism to a much more balanced view. About one year ago, there was a complacent belief in synchronized global growth as global economic momentum strengthened further – from an already high level of economic activity.
In particular US growth was strong as the fiscal stimulus reached its full force. Other regions achieved above-trend growth as well, helped by loose monetary conditions and strong private demand. As the year went by, concerns about the upcoming end of the expansion and a growing number of political events dented investor sentiment. Consequently, financial markets experienced volatility and risky assets suffered a sell-off in the past few months.
We believe the volatile market conditions are here to stay in 2019. The global economy is past peak growth in this cycle and we foresee growth to slow down in the coming period as growth-enhancing measures run oﬀ and capacity constraints materialize. This slowdown of economic momentum is likely to coincide with (monetary) policy uncertainty and further volatility. Besides the business cycle concerns, there are a number of political risks that will unfold in the coming months. Ongoing trade tensions between the US and China will pose headwinds for corporations and disrupt supply chains, whilst the lack of Brexit clarity remains a big uncertainty. Altogether, global investors will have to deal with a slowdown of economic momentum and policy related uncertainties in 2019.
In the past few months, we saw some early signs of this slowdown, as some incoming data was less strong. We argue this trend will continue for now, but do not foresee a full blown economic standstill. Apart from the negative impact from trade war, eurozone integrity and Brexit, another reason of slower growth expectations lies in the labor market. In the past years, the US economy benefited from strong job creation. As the expansion strengthened, it was easy for US businesses to employ skilled workers. Now, the labor market has fully recovered – the unemployment rate has dropped below 4% and is back at pre-crisis levels – and businesses face increasing difficulties to fill vacancies. Given these restrictive conditions, we argue that job growth momentum will weaken in 2019. In other developed markets, e.g. core eurozone countries, the UK and Japan, a similar situation is present, with unemployment measures close to their historic lows. Another important motive supporting this forecast comes from the fiscal stance. Last year, the tax overhaul and fiscal expansion boosted short-term economic growth in the US. Now, with no new meaningful stimulus in sight, fiscal driven growth is likely to dissipate in the next quarters.
Central banks in the spotlights
Central banks will continue to play an important role this year. In the developed world, the US Federal Reserve (Fed) has been applying a method of two-way monetary policy normalization via higher policy rates and balance sheet reduction. Last year, the US policy rate was increased by 1% point and the balance was reduced by about $370 billion. The Fed intends to continue the normalization path in 2019 by increasing policy rates by 50 basis points, and further reducing the size of the balance sheet. That said, the Fed has communicated that their actions depend on incoming data, leaving room to deviate from the intended policy.
In Europe, the European Central Bank (ECB) has made much less progression in normalizing monetary conditions. In 2018, the asset buying program was gradually reduced and terminated by the end of the year. European policy interest rates have remained at record-low levels for the full year. Looking ahead, we expect the ECB to tighten the policy marginally, but continue to foresee very supportive financial conditions for the medium term.
Bank of England (BoE) policy will heavily depend on the Brexit deal and it is very likely that the BoE will await clarity before making any policy adjustments. Finally, moderate growth and stubbornly low inflation in Japan have been the main reasons for the Bank of Japan (BoJ) to keep the policy very supportive. We believe the BoJ will not change the regime unless there is strong evidence of a structural pickup in inflation, which we do not foresee for 2019.
Political events create uncertainty
Last year was an eventful year when it comes to global politics, and many of the political uncertainties investors faced last year will drag on in 2019. The trade dispute between the US and China is one of the most pressing concerns. From a long-term perspective, the recent trade tension might mark a turning point in a long-term trade liberalization trend. Since 1990, a large number of preferential trade agreements were established, resulting in a widespread fall of applied tariff rates among both advanced and emerging economies. The trade liberalization coincided with intensified global trade, and the internationalization of supply chains. The admission of China into the WTO was another step toward further globalization. However, most western countries view Chinese trade practices as unfair as access to the Chinese market is restricted. Foreign companies for instance have to form joint ventures with Chinese partners, which increases the risk of intellectual property theft. The US is now taking the lead in addressing these issues, via a very confrontational approach of the Trump administration, increasing global economic uncertainty. If China does address their concerns, it might actually increase further integration of supply chains.
Also, at this moment, it is uncertain how Brexit will unfold, as a large number of scenarios could play out. Our view is that a disorderly Brexit is unlikely to trigger a global economic slowdown, but will have a serious economic impact on individual countries, specifically the UK and its main trading partners. We believe that even a well-managed Brexit will cause harm to the UK economy. In the past quarters, many companies have relocated employees and operations to continental Europe in order to secure European market access. Furthermore, investment decisions have been delayed as companies await more certainty.
A risk that resurfaced last year – be it less pronounced than in 2009 – was the lack of convergence and structural stability in the eurozone. The newly elected Italian government wanted to live up to the election promises, including welfare reforms. The EU disagreed with the budget proposal as the ambitious plans were to be financed with higher deficits. The credit premium on Italian bonds rose significantly as investors questioned the creditworthiness of the country. Now, financial markets are relatively stable and the EU and Italy have agreed on a revised budget. Nevertheless, the Italian situation highlighted the threat of eurozone instability - driven by the lack of convergence of growth, competitiveness and government finances, which will remain a concern in the medium term.
Financial markets and positioning
Financial markets experienced the end of a multi-year bull market in 2018. Growing business cycle concerns and a variety of uncertainties caused investor sentiment to change rapidly. Now, financial market risks are roughly balanced and many markets trade closer to fair values. The recent re-rating in equity and credit markets provides some safety to protect investors against slowing growth, and policy and political uncertainties.