The Multi-Asset Process

July 2019 Market Review

In a month in which the S&P 500 hit yet another high, breaking the 3000 level for the first time, it seems odd to have to point out just how delicately poised markets remain.

For now, increasing dovishness from central banks is proving enough to counteract the impact of trade fears and the Brexit saga in the UK – but how long this seesaw remains balanced is anyone’s guess. As we saw at the end of last year, even a suspicion of tightening from the Federal Reserve was enough to send markets into panic mode.

First out of the gates was the European Central Bank (ECB), which left benchmark rates unchanged but hinted at future action, which many expect means a cut at the next meeting in September. Markets had been watching for the Bank's reaction to slowing eurozone growth, and President Mario Draghi indicated he could also revive the €2.6tn quantitative easing (QE) programme in the coming months. Although he highlighted some bright spots in the eurozone, in services and construction, Draghi added that "the outlook is getting worse and worse", especially for manufacturing.

Around the world, the list of central banks easing or getting ready to do so is lengthening, mirroring the correlation of policy we saw at the height of the global financial crisis in 2008. It includes emerging markets like Vietnam and Brazil, as well as Australia, Russia, South Africa, South Korea, Chile and Indonesia among others.

In the midst of all this, the Federal Reserve followed through with a widely-trailed 0.25% rate cut at the end of July – the first since 2008 – and we appear to be in a new era of pre-emptive policy action rather than in response to any kind of market or economic excess. Given the US economy is still growing at a reasonable rate and unemployment is the lowest since the late 1960s, Fed Chair Jerome Powell highlighted trade uncertainty as the key factor behind the decision. We would also suggest the Fed feels it rushed to ‘normalise’ policy too quickly, with several hikes over recent years, but is either reason sufficient reason for a cut at this stage? It is worth remembering that at least two more hikes were tabled just six months ago.

Meanwhile, many commentators are questioning the efficacy of further QE, and it must be a cause for concern if we have reached a point where the tap is running constantly with questionable results, as turning it off risks another lurch into bear conditions.

Moving to the other end of the seesaw, we find the usual sentiment-damagers of trade and Brexit in full effect. Following a meeting in Osaka at the end of June, Presidents Trump and Xi Jinping  agreed to resume the stalled talks on trade. Trump said tariffs in place would remain but the proposed new tolls on $300 billion of Chinese imports, which would extend taxes to virtually everything China ships to the US, would not be triggered for the "time being". He then reversed himself in the early days of August, tweeting his intention to levy a further 10% on this $300 billion. 

Highlighting why many see Trump’s trade policy as politically rather than economically driven, the tariffs on $250 billion of Chinese goods have generated $20.8 billion in revenue, less than what the US has spent to support farmers hurt by the trade war, let alone compensating other affected industries. In Trump speak, however, the US is winning the war, with the tariffs punishing China while generating billions of dollars, a ‘victory’ that will allow him to continue his fight without domestic harm.

In the UK, meanwhile, our new prime minister is in place and his in-tray is full to bursting, with rising tensions with Iran and the countdown to another Brexit deadline on 31 October. With Boris Johnson – at least in public – a committed Brexiteer, the chance of a no-deal has increased but I still feel we will avoid that outcome as the Conservatives have such a small majority. Given this precarious situation, a General Election would seem likely in the coming months and with Labour and the Tories so divided, it is harder than ever to predict what may happen. Even if the Tories win a larger majority, there remain many rebels inclined to vote down a no deal so it looks like Johnson will have to renegotiate with Brussels – and he has already been told the current deal is the best one possible.

Both main parties are increasingly split between rival hardliners so it would seem those in the centre ground have an opportunity to form a new party, as we have seen around the world in recent years. This looks unlikely in the UK, however, with the Conservatives and Labour so entrenched: perhaps the only thing they can agree on is distaste for any kind of new political player entering the scene.

Should we end up with a no deal, research from the Office for Budget Responsibility (OBR) says this will plunge the UK into recession. Put together with the International Monetary Fund, the OBR's forecasts warn of a sharp decline in investment into the UK and higher trade barriers with the European Union, as well as spiralling asset prices and sterling. The Fiscal risks report estimates real GDP will fall by 2% by the end of 2020, while the UK's debt is set to spiral by an additional £30bn per year than was predicted in March. It added that the inevitable imposition of tariffs by the EU, in addition to a depreciation in sterling, will "raise inflation and squeeze real household incomes".

Elsewhere, gold prices hit their highest levels in six years as investors braced for a rate cut by the Fed and sought a safe haven amid the growing tensions between the US and Iran. Gold has been boosted by the fall in bond yields, with many of the safest sovereigns, including Germany, now negative yielding and therefore improving the lustre of the precious metal.

Despite all this, I continue to hold to my view that recession is unlikely in the imminent future. We have a US presidential election coming up next year and as we have seen, the incumbent will stop at nothing to continue the market expansion for which he claims credit, including brow-beating and threatening the Federal Reserve. China is also celebrating the 70th anniversary of the founding of the People’s Republic this year, and I would suggest President Xi Jinping will be just as keen not to be mired in a global recession amid the fireworks and parades.

For a comprehensive list of common financial words and terms, see our glossary here.

 

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Wednesday, August 7, 2019, 11:20 AM