Three trends to look out for over the coming months
With the exception of US equities, one could be forgiven for thinking that markets had closed all summer. Despite some significant economic and political events, most asset classes returned only a slight decline, with limited volatility (see chart below).
So our focus turns to the future and the factors with potential to impact markets over the coming months.
1. Trade wars: Trump strikes back
Market volatility can come from many sources, economic, stock specific and political. Idiosyncratic policy interventions such as Trump’s trade war concerns are particularly difficult for markets to price. It’s almost impossible to predict the timing or severity of any action to be taken by either Washington or Beijing or anyone else affected. It’s also just as hard to disentangle the impact these actions might have on a specific asset class.
So far, tariffs assigned to $50bn of Chinese goods imported into the US every year have impacted emerging market sentiment. However, the economic effect has been relatively benign. A mere 1% of the products on the tariff list are consumer goods. Trump is attempting to keep the consumer on side. The hit is on capital or intermediary products with his clear aim to force US companies to be less reliant on China in their supply chains. Chinese GDP and importantly GDP growth derived from exports to the US is actually minimal. Tariffs can have a knock on effect on surrounding countries whose exports to China are a stage further backwards in these supply chains. However, in the most part tariffs have not been as painful as the headlines suggest, so far.
…an all-out trade war is moving closer
However, in the coming days, Trump will decide on action against a further $200bn of Chinese imports. A further $200bn will be threatened for later, as part of his deal making tactics. While the effects of the initial tariffs have had little fundamental impact on economic growth, an all-out trade war is moving closer. It is this scenario that has markets concerned and as we speak they are duly selling off – re-evaluating the downside risk and the odds on a bad outcome.
Source: UKbusinessinsider.com, September 2018
2. Emerging markets feeling the pressure
Tighter monetary policy from the new chair of the US Federal Reserve on top of ‘trade wars’ has seen the dollar steadily strengthen as this year has progressed. Many emerging economies have funded their development by borrowing abroad, mostly in US dollars. As the dollar rises, the cost of interest and capital repayments increase in local currency terms This puts pressure on emerging market corporates and governments alike. However, while this threat to emerging markets has been a hot topic this summer, we have not seen a hard sell off. In fact, their 3 month fall is less than 2% in sterling terms, and a mere 60bp in local currency.
While there have been some specific problems from dollar pressure, Argentina and Turkey are the standout pair, other larger emerging economies have held up quite well. Again much of the fallout is still to materialise and the next two quarters could be key, especially if a full blooded trade war erupts.
Source: FT.com, June 2018
3. US interest rates: Decisions, decisions
The US Federal Reserve is in an interesting bind. On the one hand it oversees an economy that appears to be at full steam, almost in danger of over-heating. Just this week the ISM manufacturing output index, a bellwether statistic, hit a 14 year high of 61.3. A reading above 50 is expansionary, and for context, this is the second highest score since 1984. Coupled with this is the strong US consumer, and a corporate sector flying high on the tax boost Trump provided earlier in the year. This has been the backdrop for rate rises all year. Furthermore, as we approach the next Fed meeting, the expectation is for a further 25bp to be added to the Fed Funds rate. In the context of the booming ISM figure, Chairman Jerome Powell has to strike a balance between the dangers of raising rates too quickly and not quickly enough.
The flip side to the booming manufacturing picture can be seen in what the debt market has been highlighting for some time. The US Treasury yield curve has continued to flatten, with summer providing no respite. Currently the 10 year US Treasury yields a mere 24bp higher than the 2 year. This suggess that market participants do not think higher interest rates are sustainable for the medium term. In essence they are worried that economic strength will force the Fed into rate rises ultimately too aggressive for the economy to handle. Could another inflationary scare be around the corner, or are markets blinded by optimism? We will learn over the next few months.
Source: St Louis Fed, September 2018
Source: US Federal Reserve via Bloomberg, August 2018
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