The one central bank that had embarked on the monetary policy normalisation route has just stopped dead in its tracks. The US Federal Reserve’s March 20 decision not to hike interest rates at this point – nor indeed probably for the remainder of 2019 – and to go easy on balance sheet reduction provides a clear signal to financial markets: low yields are here to stay, so the risky asset rally is welcome to continue.
Helping financial markets extend their rally late February was an unexpectedly solid 4th quarter 2018 US GDP report. With the Fed now on pause, a trade deal with China seemingly at hand and Trump-promised infrastructure investments to possibly finally materialise, the largest world economy looks set to continue growing this year, breaking its post-war cycle length record.
A look at the recent performance of shipping stocks – or the Baltic Dry index (BDI) for that matter – would suggest that the end of the world is nigh. After all, transportation is typically considered a leading economic indicator, with shipping its most volatile segment. Should we really be readying for a disaster scenario?
The first day of 2019 saw the NASA spacecraft “New Horizons”, launched in January 2006, reach the Ultima Thule comet in the Kuiper Belt, at the outer limit of our solar system. “New Horizons” took some 900 amazing pictures per second during its flyby, before continuing its voyage at a dazzling speed into the unknown territory of the wider galaxy.
Photograph: Alexander Nemenov/AFP/Getty Images
Have financial markets been correcting because of underlying weakness in the real economy? Or could it be that market turmoil will be what bring this long-lasting economic upcycle to its knees? As we turn the last page of 2018, the eternal “chicken or egg” question is very much open.
October certainly lived up to its adverse reputation, with the S&P 500 index posting its worst monthly decline since 2008, equities losing ground across the globe and bond yields nearing multi-year highs. Still, rather than marking the start of a deeper and broader downturn – one that extends even beyond financial markets – we view the recent corrective episode as a drill for what awaits investors, once the tipping point is eventually reached.
What if the main victim of US-promoted trade barriers were its own domestic economy? The European Central Bank recently made such a suggestion, which is also starting to be buttressed by economic data – be it in terms of the US trade deficit or inflation.
The current outperformance of US equity indices goes beyond an investor craze for Facebook, Apple, Amazon, Netflix and Google (collectively known as the FAANG stocks). It reflects a new versus old economy battle, which is starting to have serious real-world implications. And this battle is being fought on uneven terms, with still cheap and plentiful money providing an undue advantage to new economy companies.
The market is wrong in thinking that the US have nothing to lose in a trade war with China – just as it is wrong in expecting the world’s largest economy to weaken already next year.
Trade disputes are monopolising investor and media attention, with tough talk unlikely to abate before the US mid-term elections. But what if the more serious issues for financial markets were actually mounting inflationary pressures in the US and failing political unity in Europe?
European political waters were supposed to be calmer this year, after the many electoral hurdles of 2017. But investors’ nerves were tested again in late May with the ousting of the Spanish Prime Minister (leaving his successor at the helm of a very fragmented parliament) and complicated negotiations with respect to the formation of a populist government in Italy.
An important milestone was reached on April 24, when the US Treasury 10-year yield topped 3%, threatening to undermine the form of “equilibrium” that equity markets had settled into during the past few months.
