Tuesday, November 13, 2018

November-December 2018 Outlook

TradeTheNews.com November-December 2018 Outlook: The Results Are In
Tue, 13 Nov 2018 7:23 AM EST

The return of volatility has created dread in some investors and excitement in others that see opportunity in a less complacent market. The stock market had a classic October sell off, but other markets also suffered. The junk bond market had its worst month in a decade, and the 10-year Treasury yield hit a 7-year high as markets reassessed sentiment about Fed rate tightening, even at a “gradual” and predictable pace.

With the resolution of the US midterm elections, at least one of the key uncertainties of the last year is now resolved. The outcome of the election will not only change the tenor of US politics for the next two years, but it will also influence the other major outstanding geopolitical issues that play into the assessment of the balance of risks. Now risk analysis will focus squarely on Fed rate policy, the final outcome of the Brexit deal, and the nascent trade war between the world’s largest economies.

US Election ‘Blues’

In the US, the House going ‘blue’ thwarts any White House dreams of additional tax cuts, but could result in some bipartisan issues getting more attention, particularly infrastructure spending – though it remains to be seen if Trump and the Democrats can agree on the structure of any such spending legislation (highways vs. walls). A Democratic House does give Trump a foil to run against for the next two years and he will definitely use the “obstructionist Democrats” to share the blame for any policy failures, stock market weakness, or economic downturn. On the policy level, the absence of any new fiscal stimulus could give the Federal Reserve some room to slow its monetary tightening if any red flags appear in the economic data, even as it deflects criticism from President Trump about higher rates.

The next two months could see the outcome of Special Counsel Mueller’s probe, which is reportedly near completion. Mueller was in a ‘quiet period’ ahead of the election, but with the votes counted the Special Counsel may soon be ready to announce conclusions and possibly new indictments in the wide ranging investigation of Russian election interference. It will be embarrassing for Trump if more campaign advisors are caught up in the dragnet, but there is no sense of a fatal blow to his Presidency coming out of the investigation. No sooner than Mueller is done, however, House Democrats with newly regained subpoena powers could continue to harry the White House with demands for document related to his taxes and business dealings.

The probe of Russian election tampering could also be a thorn in the side of social media companies in the months ahead. If any hint of foreign influence being exerted through social platforms comes to light, firms like Facebook and Twitter will take a lot of heat, especially from President Trump seeking to assign blame for his party’s election setbacks. The social media firms have added thousands of employees to scan for misinformation campaigns, but have confirmed that they have removed only a few hundred suspect pages and users over the last few months.

Big Decisions in Europe

The same populist wave that swept Trump into power two years ago continues to roil Europe. The official Brexit, brought about by referendum, is now just months away. Meanwhile the new populist Italian government has begun to question EU authority over its budget.

The deadline for an agreement on Brexit keeps slipping but there isn’t much leeway left with the UK scheduled to leave the Union on March 29. By all accounts, most of the Brexit outline is completed but the Irish border remains the sticking point. It will all come down to whether the EU or the UK (and specifically Northern Ireland) will bend in order to save Europe from a ‘hard Brexit.’ If there is no breakthrough in the next few weeks, there won’t realistically be enough time for a new leaders’ summit or legislative debate in the parliaments of the EU27 nations. There is starting to be some speculation that the March 29 Brexit date under Article 50 could be extended but that is not likely to gain any traction with Brexiteers in the UK. Thus European markets will be on edge for the next few weeks as they contemplate the repercussions of a hard Brexit scenario, which is becoming more and more likely.

The Italian government will be watching the Brexit proceedings with special interest. Though the coalition in Rome insists that it has no desire to leave the EU or the euro, it has been pushing back hard against limits set by the European hegemony. So far Italy’s government has been adamant that it will not make any major changes to its budget plan and won’t veer from its 2.4% deficit/GDP target despite EU objections. Instead, Rome is pinning its hopes on the economic plan creating better than expected growth.

The European Commission has given Rome until mid-November (11/13) to make adjustments to its budget plan, but so far the Italians have been unyielding. If Italy’s government doesn’t pay some heed to Europe’s ‘advice’ regarding the budget and its deficit/GDP ratio should slip further, it could lead to disciplinary action in the spring of 2019 in the form an "excessive deficit procedure." That procedure could potentially culminate in sanctions that will make it even harder for Italy to spend its way out of its economic malaise.

Trade Talks or Trade War

As the dispute over international trade grows more serious, the US election result may ultimately give President Trump a stronger hand in trade talks. Though Democrats did well enough to retake the House, President Trump showed that he can still mobilize his voters, so China and Europe may not be able to simply wait him out of office. President Xi could now be more amenable to reaching an agreement with the Trump White House rather than risk a prolonged trade conflict potentially lasting six more years.

November 30 may be a binary moment as Presidents Trump and Xi meet in Buenos Aires. Arrangements appear to be on track for the two leaders to have bilateral talks on the sidelines of the G20, their first meeting since last July. If they can show some concrete progress toward resolving the impasse on trade between the world’s two largest economies it could alleviate some of the uncertainty hanging over markets. In the alternative scenario, Trump and Xi will bump heads and offer no concessions. That outcome could hasten implementation of US threats to boost existing tariffs from 10% to 25%, signaling the start of a full blown trade war.

To date, China’s biggest export has become strong rhetoric about holding its ground. The standard line from officials in Beijing has become that they do not desire a trade war, but they also don’t fear one. President Trump has also held firm and his only offer so far has been to issue additional punitive tariffs. If the G20 meeting comes and goes with no new overtures on trade issues between the two nations, it may finally shake confidence that a compromise will be found any time soon.

If the G20 is a bust, the Chinese currency could continue to fall against the greenback and test the key psychological level 7.00, which the PBoC has verbally defended in the past. The trade dispute has already weakened both the Chinese stock market and the currency, and a break of that level could stir concerns about capital flight from China. It’s also likely to earn a rebuke from the White House, which has declined to label China a currency manipulator, but knows that the weaker yuan softens the blow of tariffs because it makes exports cheaper.

Fed Steady, Inflation Steady, Oil…

The Federal Reserve has been one of the many targets of President Trump’s ire, but continues to go about its business after the election. With the US labor market at full employment and inflation stable around 2%, the Fed has achieved its mandate and logically continues to unwind extraordinary accommodation, raising rates and paring down its balance sheet holdings. Now the focus is moving to where rate tightening should stop in order to keep the economy humming without allowing it to overheat. The Fed seems to be aiming for a slightly restrictive policy as its endgame, a bit above the ‘neutral’ rate which stands somewhere around 3.00%.

The Fed made no noises about slowing rate hikes at the November meeting, giving every indication that the committee is ready to move again in December (12/18). With the rate hike locked in for next month, the statement and updated Summary of Economic Projections will be scrutinized for any signs that the Fed might blink in the face of both market and political pressure. If inflation shows no signs of percolating higher it could conceivably give the central bank an excuse to pare back tightening expectations. There is already a wing of the Fed that appears to favor stopping at ‘neutral’ to reassess the situation before tightening any further. If that strategy prevails, it means the Fed could raise in December and once more in the Spring and then declare neutral policy has been reached. If there is a “Powell put”, a level at which the Powell Fed would take action to support sagging equity market, it can be surmised that it’s at a lower level than under past Fed Chairs. Even still, the baseline case remains that that Fed will continue hikes throughout 2019 unless there are real signs downside risks are asserting themselves on the economy early next year.

A hard Brexit and unresolved trade tensions could move the needle to the downside. So too could slower economic growth in the US if the fiscal stimulus from the 2018 tax cut turns out to be just a short term ‘sugar high’ as many economists believe. There’s not much evidence yet that the corporate tax cut has changed companies’ long term behavior as the Trump administration predicted, so growth could slip back into the 2.5% range or lower next year.

The inflation outlook is another key factor in the central bank calculus, and as usual energy prices are unbalancing the scales. After demonstrating firm pricing through much of the year, crude oil prices have suffered a 20% decline from recent highs, entering a bear market amid the bout of risk-off behavior in the broader markets, shepherded along by booming US shale production and uncertainty about the OPEC+ production agreement.

An OPEC+ gathering in Abu Dhabi punted the issue, so it will come down to the semi-annual OPEC meeting (12/6) to determine if producers outside North America want to continue efforts to support prices. Even as Iranian exports dwindle under US sanctions, world oil producers will have to decide whether to keep the market in balance or to return to an every-man-for-himself production policy.

On the geopolitical end, the White House will have to contend with European governments which are contemplating a Special Purpose Vehicle to facilitate trade with Iran, circumventing some US sanctions. The SPV idea is sure to ruffle Trump’s feathers and create a negative feedback loop into efforts to resolve tariff issues between the EU and US. If world leaders don’t elect to solve these disputes diplomatically it could ratchet up tensions in the New Year.

6: US Midterm Election
7: China Trade Balance
8: FOMC Policy Statement; China CPI

13: UK CPI & PPI; German ZEW Economic Sentiment; Japan Preliminary Q3 GDP; China Industrial Production
14: UK Claimant Count & Unemployment; Euro Zone Flash Q3 GDP; US CPI
15: UK Retail Sales; US Retail Sales; Philadelphia Fed Index
16: UK Inflation Report Hearing; Euro Zone Final CPI; Preliminary University of Michigan Consumer Sentiment

20: US Housing Starts & Building Permits; UK Autumn Forecast (tentative); Joint OPEC-non-OPEC Ministerial Monitoring Committee (JMMC)(tentative)
21: US Durable Goods Orders
23: Various Euro Zone Manufacturing & Services PMIs

26: German Ifo Business Climate
27: UK Bank Stress Test Results; US Consumer Confidence
28: US Preliminary Q3 GDP (2nd reading)
29: German Preliminary CPI; US Personal Income & Spending; FOMC Minutes
30: German Retail Sales; Euro Zone Flash CPI Estimate; Chicago PMI; China Manufacturing & Non-manufacturing PMIs; G20 Leaders Summit in Buenos Aires(day 1)

1: G20 Leaders Summit in Buenos Aires

3: UK Manufacturing PMI; US ISM Manufacturing PMI
4: UK Construction PMI
5: BOE Financial Stability Report; UK Services PMI; US ISM Non-Manufacturing PMI
6: Regular Semiannual OPEC Meeting in Vienna; China Trade Balance
7: US Payrolls & Unemployment
8: China CPI

10: UK Q3 GDP; UK Manufacturing Production
11: UK CPI & PPI; German ZEW Economic Sentiment; US PPI
12: UK Claimant Count & Unemployment; US CPI; China Industrial Production
13: ECB Policy Statement & Press Conference
14: US Retail Sales; Preliminary University of Michigan Consumer Sentiment
15: Japan Lower House Elections

17: NY Empire Manufacturing Index
18: German Ifo Business Climate; US Housing Starts & Building Permits
19: FOMC Policy Statement, SEP, & Press Conference; BOJ Policy Statement
20: UK Retail Sales; BOE Policy Statement; Philadelphia Fed Manufacturing Index
21: Various EU Flash Manufacturing & Services PMIs; UK Current Account; UK Final Q3 GDP; US Durable Goods Orders; US Final Q3 GDP; US Personal Income & Spending

27: Chicago PMI; US Consumer Confidence
28: German CPI