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Banking on Powell

26 February 2019

Welcome to Project After 2018. Not the UK cabinet preparations for a no-deal Brexit – my editor has informed me there’s a special place in hell if I talk about Brexit too much. No, Project After 2018 starts with January, following on from December obviously, but not the January that most forecasting in December would have imagined. In fact, a horrible December for equity investors was followed by one of the best months of January in history. Related to this, the VIX, “the fear index” or a measure of market volatility, has slowly fallen from a peak of 30 plus to around 15 – and still trending downwards. So how did we end up here and what might Project After 2018 look like in the future?

Project After 2018 will potentially have many similarities with Project After (the UK Cabinet one that is): political positioning, economic data and central bank policy are all entangled in creating the environment for investors. First, the US government shut down. Whilst the story has dominated press coverage markets seem not to have been too troubled by this event – it was hardly the first time it had happened. Furthermore, the latest news seems to be suggesting a likely compromise between the White House, Senate and Congress. Whether this is truly a sign of the relative fragility of the current political arrangements in the US or merely a (floppy haired) ginger herring, this seems unlikely to be the news story dominating markets. 

So what else? Trade war fears between the US and China and a simultaneous Chinese economic slow-down? At present US tariffs apply to around $250bn of Chinese products, with a threat of this doubling. The Chinese in part have responded with $110bn of tariffs, and the threat of further measures if no deal is agreed. Most commentators agree that the impact of these tariffs is likely to be far greater on the Chinese economy than the US, if implemented. This is particularly the case as the Chinese economy is already in slowdown – at this stage we’d typically give some reliable growth or GDP figures, but these are remarkably hard to come by for the Chinese economy... However, global markets remain fearful that a significant trade war between these two powerhouse economies, which have produced the lion’s share of global growth for the last decade, would likely drag the rest of the world down with them. In December fears of a significant trade war were high and markets suffered. As these abated in January, markets rallied. The story at present remains lurking in the background but may resurge in early 2019 causing significant damage to markets.

Related to the above, there are significant global growth fears; as there have been for a period. Whilst the US economy remains strong, it is moderating with a GDP growth at c3.4% over the past year. However, the UK and Europe remain in the doldrums with GDP growth in the 1-2% range for the year. Forecasts for Europe in particular remain low; in part due to the B word, and in part due to ongoing concerns about member state economic strength (Italy in particular is worthy of note here). With no great strength expected in Europe this puts greater pressure on the US to generate global growth – with or without a trade war. The markets have responded to this data, however most assets assume low economic growth and it’s likely that market data combined with policy response is what really interests investors now.

So central bank policy stance. Here’s an interesting one. The UK wants to raise rates. It really does. But with the B word dominating current conditions, it can’t and likely won’t be able to for some time if the B word goes wrong. Arguably though, no one really cares about what the BoE does except UK bond holders – and of course pension schemes are amongst the most important of these. All investors do however care about what the US Fed does, and the Fed has taken two rather conflicting decisions. Firstly in December to raise rates to 2.5%. Then in January to cut forecasts for further raising of rates (in light of weaker US data) with forecasts of US rates hitting 3.1% in 2020 vs the 3.4% previously estimates. The lowering of rates expectations, or slowing of rises, were great news for equities.

This balance of policy response between rates to growth is likely to be a key driver for the markets in 2019. Pension schemes should reflect on the level of equity exposure they hold, whether they can afford this exposure to central bank policy response, and the substantial gains they have made in recent years. 2019 should be a year to gradually take profits and position portfolios for the turning of the economic cycle into the next decade.

The author

Alastair Greenlees

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