TradeTheNews.com 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.
Roma
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.
Vice
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.
BlackkGold
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.
MARCH
4:
5: UK Services PMI; US ISM Non-manufacturing PMI
6:
7: ECB policy decision & press conference; China Trade Balance
(tentative)
8: US Payrolls & Unemployment; Preliminary Univ of Michigan Confidence
11:
12: UK Manufacturing Production; US CPI
13: US PPI; China Industrial Production
14: US Retail Sales; BOJ policy decision
15:
18:
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
25:
26: US Durable Goods Orders; US Consumer Confidence
27:
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
APRIL
1: UK Manufacturing PMI; US ISM Manufacturing PMI
2:
3: UK Services PMI; US ISM Non-manufacturing PMI
4: ECB Minutes
5: US Payrolls & Unemployment
8:
9:
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
19: GOOD FRIDAY HOLIDAY
22: German Ifo Business Climate
23:
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
MAY
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
