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.
CALENDAR OF EVENTS
NOVEMBER
6: US Midterm Election
7: China Trade Balance
8: FOMC Policy Statement; China CPI
9: US PPI
12:
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
19:
20: US Housing Starts & Building Permits; UK Autumn Forecast (tentative);
Joint OPEC-non-OPEC Ministerial Monitoring Committee (JMMC)(tentative)
21: US Durable Goods Orders
22: ECB Minutes; THANKSGIVING HOLIDAY (US)
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)
DECEMBER
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
24:
25: CHRISTMAS DAY HOLIDAY
26:
27: Chicago PMI; US Consumer Confidence
28: German CPI
31:
JANUARY
1: NEW YEARS DAY
