Wednesday, March 6, 2019

March-April 2019 Outlook: Best Picture March-April 2019 Outlook: Best Picture
Tue, 05 Mar 2019 15:28 PM EST

The markets appear to have overcome late 2018 worries about a global recession and have resumed a narrative of cautious optimism that growth can continue and extend the aging bull market. The same macroeconomic stories that have projected uncertainty on to the markets for the past two years continue to linger, despite some hard deadlines that were supposed to offer resolution during the first quarter of 2019. By this point, market watchers are saying “haven’t we seen this already” and wondering when this storyline is going to end.

It now appears the Brexit will be pushed back from March 29, with no clear solution to the seemingly irreconcilable dispute over how to handle the Irish border issue. Meanwhile the Trump administration has postponed higher tariffs on China slated for March in light of trade talk progress. But even if a US/China accord is reached, more tough trade negotiations lie ahead with Japan and Europe, while the ‘new NAFTA’ has yet to be ratified.

Slowing growth remains a headwind, and persistent strength in the greenback is moderating gains for the US economy, which has been the star of the global recovery. Piecing together the outcomes of these disparate macro issues, we can form the best picture of which way the global economy will move over the months ahead.

Green Book

If the stock market is to be used as an indicator, then the early 2019 economy (especially in the US) is a blockbuster compared to recent years. The accumulated uncertainties that knocked the S&P500 into correction in December have eased, and Wall Street is seeing a lot of ‘green’ books after the breathtaking rally in stocks through February.

The extent to which this market rebound will continue may depend on the strength of the US consumer, who is facing some troubling indicators. December advance retail sales saw their biggest drop in almost ten years, and the National Retail Federation reported that holiday sales were substantially below initial rosy expectations. Early 2019 auto sales have also been mediocre, with February marking the lowest industry sales rate (SAAR) since August 2017, while auto loan delinquencies are at the highest level since they peaked in 2010, presenting a possible early warning sign. The same holds true for the housing market, as uncertainty over where mortgage rates are heading contributed to January existing home sales dropping below five million, to the slowest rate since November 2015. It remains to be seen if the weak December retail sales and other data were an anomaly driven by the government shutdown as the White House suggests. Clearly auto and home sales need to show improvement to evidence that consumers aren’t turning cautious, and the spring selling season may give a better read on how the housing market is doing amid the prospect of higher rates.

Though the rapid dovish evolution in Fed policy ignited the stock market rebound, the sustained rally is largely attributed to growing hopes for a US/China trade deal. The White House is said to be aiming for an agreement within weeks so that a signing ceremony can be held by late March, and the latest reports say that China is offering to lower tariffs on US farm goods and autos, and that the US may reciprocate as they close in on a final deal. Negotiations could still hit a snag (e.g. frictions over Huawei or an allegation of currency manipulation in the Treasury’s upcoming semiannual report), but market optimism that a deal will get done remains high.

The question is how much of this optimism is already built into the market and whether a China trade deal could be a “sell the news” moment. The answer will depend on the actual structure of the final China trade deal. Recent reports highlight offers for deficit reduction through China buying more US goods, but the key will be the extent of the structural changes that China agrees to in order to protect intellectual property, reduce subsidies for state owned enterprises (SOEs), and allow US monitoring and enforcement of compliance. That may only be answered by an analysis of what concessions are in the final document.

Assuming the China deal gets signed, there is still another looming round of trade talks that can impact market sentiment as the White House gets into bare knuckle negotiations with trading partners in Europe and Japan, largely focused on the automobile industry. The US Commerce Department has reportedly furnished the White House with a menu of options ranging from a 10% or 25% across the board levy to more targeted customs duties on specific automotive technologies. It may be a couple months before President Trump makes a final decision regarding auto tariffs.

For its part China is definitely feeling the impact of the US tariff regime on its economy, and has initiated a number of stimulus efforts to counteract the effects as the negotiations wear on. Beijing’s latest plan to help the economy is said to be a $90B cut in VAT for manufacturers. In addition, the annual meeting of the People’s Congress just affirmed that fiscal policy will be “proactive” and monetary policy will remain “prudent” this year, targeting GDP growth of 6.0-6.5% compared to about 6.5% last year. Given these numbers, if the terms of the US trade deal leaves the Chinese economic outlook in worse shape, it could amplify the global slowdown that is already troubling forecasters.

The Favourite

In the UK, economic malaise has persisted in the face of all the uncertainties around the Brexit. PM May is certainly no one’s favourite, but she continues to single-mindedly focus on implementing “the will of the people.” The odds are that the Brexit is still going to happen, though now it appears that the exit date will be pushed back, in what is being couched as a “short technical extension.”

In the weeks leading up to the March 29 deadline, the EU has made it clear it does not want to reopen Brexit negotiations over the UK Parliament’s objections to the Irish border backstop. The last month of discussions haven’t made any significant headway, as the EU has stood fast to its stance that it can only provide “assurances” in a political declaration on future UK/EU ties, but will not reopen negotiations on the exit agreement that the British parliament subsequently rejected. In the most recent overture to end the deadlock, EU negotiator Barnier suggested that he would be willing to give further assurances that the backstop is only temporary, potentially via a commitment to limit the backstop through an agreement on the future relationship between UK and EU (which is to be negotiated next). It’s unclear if this will be enough to win over Parliament.

Meanwhile PM May has toned down her implied threats that the UK is willing to crash out of the EU in a ‘no deal’ Brexit, helping to strengthen the pound sterling over the last few weeks. The PM has laid out a plan for a series of votes that appear likely to result in the Brexit date being pushed back a few months. By March 12, the Parliament will have its ‘meaningful vote’ on whether to support the negotiated Brexit agreement on the table. That failing, MPs would then hold votes on blocking a ‘no deal’ Brexit and ultimately on extending Article 50, which would push back the exit date.

This plan got a lukewarm reception from the EU, who welcomed PM May’s efforts to get her house in order, but also warned Britain not to kick-the-can just because the problem is difficult. The EU wants to see a realistic endgame from Britain.


Despite all of the focus on Brexit, it is not Europe’s only concern. Italy, after struggling last year with its budget plan and a banking system still thick with non-performing loans, recently reported its second contractionary quarter in a row, entering a technical recession. Italy’s lack of growth was emblematic of worse than expected data across much of Europe, and even the vaunted German economic engine showed zero quarter-over-quarter growth in the fourth quarter.

The coalition government in Rome continues to suffer from internal disputes over how to shore up the ailing domestic economy. This was exemplified by reports that the Northern League had drafted a proposal for a Constitutional change that would allow the government to sell gold reserves, an idea that was subsequently poo-pooed by the Italian central bank and then denied by party officials.

The ECB has its eye on Italy and says it’s not a threat at this time, but central bank officials have acknowledged that the economic slowdown across Europe has been sharper and broader than expected. Weakening growth in Europe has already prompted speculation that the ECB will have to reconsider its plans for policy normalization and instead launch fresh stimulus efforts to prevent recession from expanding beyond Italy. To that end, the ECB has already discussed the possibility of a new TLTRO program to bolster banks that are facing a funding cliff as the last round of cheap 4-year TLTRO loans doled out from 2014 to 2017 start maturing. However, the ECB will probably put off major policy changes for a while longer, leaving the big decisions to the yet-to-be-named new ECB President, who will be appointed later this year.

“Nothing Really Matters” (Bohemian Rhapsody)

When it comes to Federal Reserve monetary policy, ‘nothing’ really does matter as the central bank has decided to pause and assess at least through the first six months of the year. In the last couple months it seemed that Fed policy would go ‘anyway the wind blows’, as the rate forecast was cut back from three additional hikes in 2019. In one of the swiftest outlook changes in central bank history, Chair Powell appeared to take his cue from the bearish December stock market, lowering his estimation of the ‘neutral’ rate and suggesting that the Fed balance sheet reduction is not on auto-pilot and could finish within the year. That would cut short the Fed’s own prior estimate of balance sheet reductions by over $300 billion.

The wholesale changes made to the FOMC statement in January demonstrated that the Fed Chair’s new practice of holding a press conference at every meeting means that every meeting is ‘live’ for potential policy moves. The key change in January was to the forward guidance, taking it from “some further gradual increases” being warranted, to a “patient” stance. It also removed a reference to risks being “roughly balanced’, implying that global uncertainties are tilting to the downside.

The March 20 FOMC meeting will give the Fed another chance to revise its script as it releases the updated Summary of Economic Projections. With several Fed officials now specifying that they see only one or less rate hikes this year the ‘dot plot’ could be ratcheted down further towards what Fed funds futures are predicting. Market pundits are now debating whether the Fed will hold fast to forecasts for rate hikes to continue later this year, or as Fed fund futures indicate, keep rates on hold or even reverse course with a cut. Currently, Fed funds futures predict only a 10% chance of one rate hike by December, and many Wall Street forecasters are laying odds on a cut as growth slows this year.

The hawkish wing of the Fed could make a cautious comeback later this year if some macro concerns like China trade and global growth dissipate, but it appears more and more likely that US monetary policy could be on hold for most if not all of 2019. But even with that and the balance sheet reduction being cut short, some Wall Street wise men like Jim Grant have warned that monetary policy normalization will have consequences for an economy that has been capitalized for ultra-low interest rates.


Much has been made of President Trump’s unprecedented criticism of the Fed Chair that he appointed over tighter rates and the strong dollar. It exemplifies the “dysfunction” that has become Washington DC’s most obvious vice. Another prime example is the record-long government shutdown that has already put a cloud over first quarter GDP. The gamesmanship over the government shutdown may only be a prelude to a potentially more dangerous legislative battle over the debt ceiling.

The debt ceiling was suspended in 2017 by legislative decree, but was just reinstated on March 2 at the current $22 trillion level. The Treasury has already confirmed that it will utilize its ‘extraordinary measures’ which the CBO has estimated can prevent the government from hitting the debt ceiling until late in the current budget year, which ends on September 30.

During the Obama administration, conservative congressional Republicans used brinkmanship on the debt ceiling to extract certain budgetary concessions. Taking a cue from this, President Trump may see the debt ceiling as a new opportunity to leverage Congress to endorse his policy agenda. Unfortunately that would create new uncertainties for global markets which would have to factor in the risk of a US government default, however remote. Ratings agency Fitch has already warned that if the debt ceiling becomes a problem it will have to consider whether America’s ‘AAA’ sovereign debt rating is “consistent”.

Fractious politics are also threatening the USMCA treaty, Trump’s main achievement in trade so far. Among other changes, Democrats are demanding stronger labor standards as part of the agreement. The President already tried to apply pressure on Congress in early December when he pledged to formally withdraw from NAFTA, which would give lawmakers a six month window to ratify the new trade treaty or end up with no agreement at all, potentially wreaking havoc on North American supply chains. Some press reports suggest Trump could ultimately offer an infrastructure spending package as a sweetener for Democrats to get on board with the USMCA.

The drama of the Mueller report also continues to hang in the toxic atmosphere of Washington, distracting the President and causing some Democrats to unrealistically dream about impeachment (which, even if successful, would simply install Trump’s ‘Vice’ Mike Pence in the Oval office). If reports are true, the Special Counsel could submit his findings to the Justice Department within weeks, creating fodder for the news media for weeks, especially if the DOJ withholds the full report and it subsequently leaks out piecemeal. As recent House investigative hearings have shown, the Mueller report is also likely to inspire more probes into various aspects of the Russian interference case, continuing to nettle the Trump administration as the new Presidential election season gets underway.


Political pressure has also been at play in the energy markets, with particular focus on Venezuela and Iran. Sanctions, on top of years of mismanagement of the domestic energy industry, have slowed Venezuelan exports to a trickle – oil sales are at a three decade low and production is at its lowest since the 1940’s. Under scrutiny from the international community, demands are growing for the Maduro government to hold free and fair elections, which appears to be driving Venezuela toward a regime change that could further disrupt its oil industry.

The Trump administration’s economic sanctions on Iran’s nuclear program also continue to crimp oil supplies. Although the US granted waivers to eight countries including China, India, Japan and South Korea, allowing them to wean themselves off of imports of Iranian oil, those waivers end in June. India is said to be in talks for an extension and others may be granted on an ad hoc basis, but Iranian supplies continue to get squeezed out of the market.

President Trump has also been jawboning the broader energy market, recently tweeting that oil prices are getting too high and calling on OPEC to “relax and take it easy.” Reportedly OPEC and their partners were not moved by his exhortations, and plan to urge members toward even greater compliance with the production cutting agreement, which has been effective in firming up energy prices. A rare extraordinary meeting of OPEC members on April 17-18 will review the progress made under the production cutting plan, but no decision on modifying the agreement is expected until the regular OPEC meeting in Vienna on June 25.

And the winner is…?

Given the aforementioned events what is the best picture we can form about the months ahead? Starting with monetary policy, the Fed, along with other global central banks pondering normalization, can stay on the sidelines until inflation or reinvigorated growth emerge, both of which don’t seem to be in the cards in the near term. Firming energy prices should keep a floor under inflation, but even greater compliance from OPEC+ isn’t likely to drive oil futures and the pass through to consumers much higher this year.

The pause in Fed policy should support a reasonable risk-on environment for the next few months, and a meaningful Sino-US trade deal would bolster positive sentiment. But other trade battle still loom ahead, and the Brexit process has no end in sight, which may be enough to fuel continued uncertainty in the macroeconomic picture. Europe can stave off recession, possibly with a little well timed assistance from the ECB, and assuming the UK doesn’t crash out of the EU.

Rising political tensions within the Washington beltway will also contribute to uncertainty, but the strife would have to reach unprecedented proportions to drive the US into a serious test of the debt limit. Ultimately there are a lot of paths to losing scenarios for the global economy, but it would take some serious missteps by the leading actors to completely derail a promising season for the markets.

5: UK Services PMI; US ISM Non-manufacturing PMI
7: ECB policy decision & press conference; China Trade Balance (tentative)
8: US Payrolls & Unemployment; Preliminary Univ of Michigan Confidence

12: UK Manufacturing Production; US CPI
13: US PPI; China Industrial Production
14: US Retail Sales; BOJ policy decision

19: UK Unemployment; German ZEW Economic Sentiment; US Housing Starts & Building Permits
20: UK CPI & PPI; FOMC policy decision & press conference
21: UK Retail Sales; BOE policy decision; US Philadelphia Fed Manufacturing Index
22: Various European Flash Manufacturing & Services PMIs; German Ifo Business Climate

26: US Durable Goods Orders; US Consumer Confidence
28: US Final Q4 GDP
29: UK Current Account; UK Final Q4 GDP; Euro Zone Flash CPI; Chicago PMI
30: China Manufacturing & Non-manufacturing PMIs

1: UK Manufacturing PMI; US ISM Manufacturing PMI
3: UK Services PMI; US ISM Non-manufacturing PMI
4: ECB Minutes
5: US Payrolls & Unemployment

10: UK Manufacturing Production; ECB policy decision & press conference; US CPI; FOMC Minutes
11: US PPI; OPEC extraordinary meetings
12: Preliminary University of Michigan Confidence

15: China Q1 GDP
16: UK Unemployment; German ZEW Economic Sentiment; US Retail Sales; China Industrial Production
17: UK CPI & PPI; US Housing Starts & Building Permits
18: UK Retail Sales; US Philadelphia Fed Manufacturing Index

22: German Ifo Business Climate
24: Various EU Flash Manufacturing & Services PMIs; BOJ policy decision
25: US Durable Goods Orders
26: US Advance Q1 GDP

29: US Core PCE; US Personal Income & Spending; China Manufacturing & Non-manufacturing PMIs
30: Euro Zone Flash Q1 GDP; Chicago PMI; US Consumer Confidence
**US Treasury Currency Manipulator Report tentatively due in April
1: US ISM Manufacturing PMI; FOMC policy decision & press conference
2: UK Manufacturing PMI; BOE policy decision
3: UK Services PMI; Euro Zone CPI Flash Estimate; US Payrolls & Unemployment