Weekly: Breathing space
- Fed and ECB have taken on an asymmetric monetary policy stance...
- …the bar to tighten is much higher than the bar to ease
- A limited US-China trade deal takes away uncertainty for at least a few months
- We expect equity froth to remain, US dollar to weaken, yields to rise, and EM to rally
- This presents considerable breathing room for markets and economies going into 2020
From the Fed to ECB to phase one trade deal to UK elections—everything has gone the markets’ way this week. This presents considerable breathing room for markets and economies going into 2020.
First, the year’s final monetary policy meetings from key central banks paved the way for a highly accommodative stance to be maintained in 2020. Both the Fed and ECB have taken on an asymmetric monetary policy stance—the bar to tighten is much higher than the bar to ease. Consequently, even if inflation picks up a tad next year, there will be little concern about monetary policy turning hawkish.
In her first meeting as ECB president, Christine Lagarde made it clear that interest rates will stay at record lows in 2020, although she saw a modest pick-up in lending and a marginal improvement in the outlook. Receding risk of a disorderly Brexit and some improvement in trade related sentiment will likely help reduce the pernicious risk of negative rates in the Eurozone, in our view.
In the US, the Federal Reserve also signalled a prolonged pause ahead, with a striking asymmetry in the policy stance. By announcing a dramatic increase in market intervention (through repurchase operations), the Fed also made it clear that it is determined to avoid the type of cash crunch that disrupted markets in September. From our perspective, the Fed has clearly moved on from the “midcycle adjustment” type thinking to a more dovish strategy, with a pledge to hold rates low as long as inflation is muted. In this context, what is remarkable is the convergence of views among FOMC participants: in September, seven out of the twelve expected the Fed funds rate to be above 2% in 2020; this week everyone saw the rate to be below 2% next year.
After months of back and forth and scaling back of the scope of trade negotiations, a limited US-China trade deal arguably reduces global market uncertainty for at least a few months. Key issues remain unresolved, however, leaving considerable risk on the table for next year.
The contours of the phase one agreement feature the following:
• China to import USD50bn worth of farm goods annually (the corresponding figure in 2017 was USD24bn).
• China to tighten intellectual property protection.
• China to open up its financial services market to US companies.
• US to refrain from imposing new tariffs on Chinese goods bound for the US.
• Existing tariff on USD360bn of Chinese goods will be partially rolled back.
• Tariffs can be snapped back if China does not live up to its obligations in the deal.
Thornier issues like subsidies for state enterprises and technology transfer will be part of a subsequent deal, which will take at least another year or longer.
Exit polls suggest a resounding win for the UK Conservative Party under the leadership of Boris Johnson, paving the way for Brexit next month. The considerable majority will help PM Johnson to end the three-year political standoff, and move on to negotiating a post-Brexit trade deal with the EU. Independent of how challenging or protracted those negotiations turn out to be next year, the short-term implication for UK markets is unambiguously positive, with the British Pound the clearest beneficiary.
What do these developments mean for the early part of 2020?
• Already expensive equity markets to become even more costly, riding on a relief rally with so many uncertainties dissipating.
• Capital flows to become more emerging markets oriented (helping hard currency debt issuers) and the US dollar to weaken as non-US prospects improve.
• Fixed income curves in developed markets bull steepen somewhat.
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