TradeTheNews.com May-June
2019 Outlook: And They’re Off!
Wed, 08 May 2019 10:48 AM EST
After stumbling in the final furlong of 2018, risk appetite is off to the races
again in the first four months of this year. A yield curve inversion spurred
fears that a recession was looming and heading into first quarter earnings
season there were concerns that corporate results would flat line. But with Q1
now in the books, earnings have been better than expected and economic growth
appears to be firming up.
A number of risks to the economic outlook appear to have been scratched from
the lineup: the Fed and other central banks have stopped tightening policy,
global growth indicators have been mostly better than expected, Brexit has been
postponed, and US/China trade talks seem to be making headway. Minimizing these
concerns has led to the better risk appetite in recent months, but as we have
just witnessed this past weekend, sometimes the longshot comes through, so it’s
only prudent to consider the outlying alternatives. A number of potential
political, monetary, and economic missteps could still befall the markets and
shake the current generally positive outlook.
Politics: Putting on Blinders
The political environment in western democracies has been like a rain soaked
track in recent years – conditions are sloppy and mud is splashing everywhere
(much to the delight of Russia and other actors that have sought to exacerbate
those muddy conditions). In these circumstances, it has become more and more
difficult for political opponents to work across the aisle, but there are still
some opportunities for bipartisan deal-making.
The US political environment was not cleansed by the Mueller report, it has
only gotten dirtier. Instead of making any direct recommendations about how the
President should be treated based on the evidence, Mueller left it up to
Congress and the new Attorney General to decide. This left the White House to
trot itself into the winner’s circle declaring “total exoneration,” while
Congressional Democrats disqualified the AG’s interpretation of the text and
are now calculating the political odds around dragging out the Russia
investigation with endless hearings or a slap on Trump’s wrist via an
impeachment that the Senate will never act on.
While relations between Capitol Hill and White House are as contentious as
ever, both sides are still trying to make a show of bipartisanship, expressly
on an infrastructure initiative. Initial meetings between the President and
senior Democrats came away with a call for a $1-2 trillion investment package
to rebuild America’s transportation and communication networks. However, the
politicians have not agreed yet on any funding mechanism, and many Republicans
are already bucking the idea of a gasoline tax. The debt ceiling is the other
big issue to watch this summer in Washington. The threat of a US default has
been used as political leverage in the past (most notably in 2011 when a
standoff resulted in S&P downgrading the US sovereign rating to AA+), and
in the unpredictable state of national politics in the Trump era, the risk
can’t be ignored as a longshot.
The elections for European Parliament in late May are becoming another
contentious horse race. Conservatives in the UK are upset that they will have
to participate in the elections because of the Brexit delay, stiffening their
resolve to throw PM May out of the saddle.
Unable to whip her own party into passing the Brexit bill, the PM is now using
the carrot to bring the opposition on board. The latest reports indicate that
PM May is prepared to concede on workers’ rights and a Customs Union in order
to get support from the Labour Party for a Parliamentary stamp of approval for
the Brexit deal. The key point for the PM appears to be getting a deal approved
before EU parliament members are seated later this year, in an effort to
save some face within her own party. The same report says that Labour leader
Corbyn is now deciding whether to make the deal or drag it out through EU
elections in order to inflict maximum political damage to the Conservatives, a
tactic that could scuttle the chances of an agreement altogether.
At this point, PM May faces long odds on staying in her post through the end of
the year. She has already offered to step aside once she has steered the UK
into a Brexit deal, but some Tories still want her to specify a resignation
date. The question this summer may be who even wants to lead the Conservatives
after the savage rebuke the party received in recent local elections from rank
and file members grown disillusioned with the infighting among MPs.
The EU elections could also be a new marker for the state of the nationalist
movement across Europe. Notably in France Marine Le Pen’s far-right National
Rally party is leading President Macron’s En Marche by a nose in the polls
ahead of the continental elections. Le Pen is working hard to capitalize on the
‘yellow vest’ protests and a win for her party could reinvigorate the
nationalist movement across Europe that sired the Brexit referendum and the
maverick Italian government that is butting heads with Brussels while
cultivating ties with Moscow.
Monetary Policy: The Race is Canceled
Amidst last year’s “synchronized global growth” scenario, it appeared that
central banks were jockeying to see who could win the policy normalization
race, but emerging concerns about weak growth and inflation led them to rein in
any hawkishness. The assurance of continued easy monetary policy has done more
than anything to run off recession fears.
The Federal Reserve made arguably the quickest policy reversal in its history
this past winter, but it’s still not clear if the central bank will give the
markets (and White House) the rate cuts they want. The FOMC’s May 1 statement
chose to emphasize the weaker growth indicators rather than trumpeting Q1’s
3.2% advance GDP reading, and also announced a surprise 5 basis point cut in
the IOER that is used to guide rates into the target range. Some Fed watchers
saw the IOER cut as a signal that the Fed’s next rate move is tilted toward a
cut, but Fed Chair Powell took pains to stress that the IOER move was a “small
technical adjustment,” and not a policy shift. Powell also reiterated that the
Fed would be patient, saying there is no strong case for moving rates in either
direction right now. That, coupled with his explanation of below target
inflation being caused by “transient” factors, may put a damper on market
expectations for a 25 basis point rate cut later this year.
After Powell staked out his position, Fed doves made the case that inflation
expectations may be running too low. Fed Presidents Evans and Bullard both took
note of the recent weakness in core PCE readings, saying that the Fed can’t
claim victory on its inflation mandate and hinting that they might support
future rate cuts in order to spur inflation toward the target. Evans further
suggested that the Fed might need to aim at above 2% inflation to get back to
the target level. Bullard indicated he would be open to a rate cut in the
autumn if inflation remains subpar, saying that a rate cut during ‘boom times’
would show the Fed is serious about achieving its inflation target. More weak
PCE data in the months ahead could embolden the doves to lodge a dissent later
this year.
In a less dramatic fashion, the Bank of England also slowed its normalization
process, as it awaits a resolution on Brexit. This month’s meeting of the BOE
resulted in a less hawkish statement than expected, now indicating that it may
just need one more hike to get inflation in check (versus the prior forecast of
one hike per year for the next three years). If the Brexit process turns out to
be a smooth ride, the BOE could always revert to its original strategy.
Over in its lane, the ECB has not only put normalization back in the stable,
it’s trotting out new stimulative measures as well. In March the ECB froze any
rate hikes at least until next year, pushing it back from prior guidance of
summer 2019. And to ensure ample liquidity to commercial banks, a third round
of targeted long-term refinancing operations (TLTRO-III) will be loaded into
the chute in September, in time to replace the last of the TLTRO-II
low-interest loans that will mature next year. Many healthier European banks
may refuse to take the restricted loans, and the ECB will have to make the case
that the liquidity program is not just a thinly veiled effort to prop up ailing
Italian banks that are still at risk of being taken behind the barn and shot.
It’s also worth noting that Mario Draghi’s 8-year term as ECB President ends in
October, so these new policy operations will be guided by his yet-to-be named
successor.
As always, growth and inflation are the driving forces in the monetary policy
race. Both factors have been running slow for most of the G20 economies, but
recently tabulated Q1 data has shown some promise.
Preliminary readings on Q1 GDP in China and the Euro Zone were slightly better
than expected and the BOE has raised its growth forecast for the UK. The
advance reading of US first quarter GDP was even better, coming in at over 3%
-- especially impressive considering GDP has usually stumbled out of the
starting gate for the last ten years running. The more cautious market touts
note inventories played heavily into the elevated US number, and that the
implications of the partial government shutdown may not have been fully read
into the advance data, so the second and third revisions of GDP might be
ratcheted back. Notably the Atlanta and NY Fed estimates for Q1 GDP both ended
on 2.7%.
Inflation has also been problematically low for most global economies, even
after a decade of extraordinary stimulus. Euro zone CPI was better than
expected in April, led by a jump in German inflation, though still hovering
well below target. US core inflation data has tailed off in recent months,
leaving the Fed nonplused again.
One factor in contributing to muted inflation last year was depressed oil
prices, but energy prices have perked up lately. The slow choking off of
Iranian oil and the potential for Venezuelan and Libyan supply to drop suddenly
are upside risks to the oil market. In response to the tightening net of US
sanctions, Iran is threatening to block the Straight of Hormuz and to resume
certain nuclear enrichment activities. Meanwhile the Maduro regime’s days
appear to be numbered which could result in more Venezuelan production
disruptions in the near term, while Libya’s undeclared civil war disrupts oil
fields on a day-to-day basis. Extreme weather is always a upside risk to energy
prices as well, so market participants need to keep abreast of meteorological
models as the Atlantic hurricane season kicks off on in June.
There is also a case for downside risks in oil prices as OPEC and its
partners reconvene in late June (June 25-26) to discuss the production cutting
agreement that has been the stabilizing force behind the market for two years.
Member states agreed to an additional 1.2M bpd in cuts at the beginning of the
year and will decide in June whether to keep production reined in. Under public
pressure from President Trump to cut prices, Saudi Arabia has resisted raising
production stating merely that it will meet market demand. Russia continues to
cooperate but seems more eager to reopen the taps, concerned that US shale
producers are gaining too much advantage from the discipline that OPEC+ is
showing.
Global Trade: Run for the Roses
Perhaps the biggest geopolitical issue hanging over the economy is the
rewriting of the global trade regime. Central to this is the negotiation of a
new trade agreement between the world’s two biggest economies. White House
officials have been trumpeting progress in the deal talks with China for several
months, but negotiations are getting trickier as they round the final bend.
Reportedly China has backtracked on some earlier commitments, prompting
President Trump to order a new round of tariffs imminently. China retaliated by
shrinking its delegation in Washington this week, all but assuring a final deal
won’t close this month as the White House had hoped. The timing of new North
Korea missile tests coinciding with this trade talk ‘impasse’ also raises
suspicions that China is demonstrating what its lack of cooperation could mean.
Although the rhetoric is clearly getting tougher, most experts are still
convinced the trade deal will reach the finish line.
The risk factors around the anticipation of a Sino-US trade pact mostly come
down to the final details and the timing of the deal. That is to say the
quality of the actual agreement matters. Although President Trump has
proclaimed it will either be a “great” deal or no deal, there have been reports
over the last several weeks that the Washington negotiators were mulling
certain concessions to get an agreement done quicker. For its part, China is
said to be particularly resistant to demands for stronger commitments on
technology transfers and IP protections that would require significant changes
in domestic law and enforcement.
If the actual terms of a new trade deal aren’t as rosy as the White House has
been boasting, markets may express their displeasure. At the other end of the
spectrum, there’s also a chance that the terms could be unexpectedly difficult
for China’s economy to adjust to, perhaps saddling one of the world’s growth
engines with more new regulations than it can’t handle in the short term.
Even if the US and China successfully negotiate a deal, global trade tensions
won’t cease. The White House has made it clear that Europe and Japan are next
on its list for trade overhauls, and the North American trade deal (USMCA) is
still not officially in the books. As Japan and Europe open trade discussions
with the US, they are already balking at threats of new auto tariffs.
Meanwhile, the USMCA is facing challenges from Congressional Democrats who want
more assurances on labor rights and environmental impacts, and Mexico and
Canada continue to complain about Section 232 steel tariffs. Tensions over these
trade issues may overshadow other considerations at the upcoming G20 summit in
Osaka (June 28–29).
Predictions: Down the Stretch…
With economic growth potentially about to break into a canter again and central
banks keeping policy normalization entirely off the track, the bulls look to
have the advantage in the near future. Yet, despite the positive catalysts,
more volatility should be expected, as uncertainties remain.
First, the rapid Fed reversal since December has underpinned the risk-on tone of
the markets, but the betting seems to be shifting away from the rate cut
scenario that some market watchers want. Chair Powell’s insistence that core
inflation weakness is “transient” casts doubt on the prospects of the Fed
lowering rates to spur inflation. However, Fed doves are still making the case
for a cut if inflation can’t pick up the pace, and Powell has now demonstrated
that he is open minded about quick shifts in policy, despite the chance that
such moves can erode confidence in Fed forecasting.
Inflation should get a boost from the energy market if OPEC+ can keep its
alliance intact past June. Lower flows from Iran could allow other producers to
modestly raise output without violating the spirit of the production cutting
agreement. The growing animus between the US and Iran governments should not be
ignored on the chance that President Trump’s more bellicose advisers push him
into a military confrontation for security or political reasons.
Trump’s re-election aspirations hinge upon the economy remaining strong, and a
China trade deal could be the key to defeating the growing field of Democratic
challengers. Some show of bipartisanship through an infrastructure package
could also help his chances, though the odds of a deal with the Democrats diminish
every day that the 2020 election draws closer. The Democratic hopefuls will
hold their first debate late next month (June 26-27), and their swipes at the
President may ruin Trump’s already limited appetite for compromise. Trump is
feeling his oats after the 3.2% advance Q1 GDP print, but watch for the GDP
revision on May 30 – if it sees a substantial downside revision to below 3%,
the White House may be more willing to get back to horse trading.
Markets have been pricing in a favorable outcome to the US/China trade talks,
but are now coming to grips with fact that reaching a final deal will be
challenging. Pricing in the trade tensions again may lead to a short term
correction in markets as traders hedge against the possibility of an all-out
trade war. But those tensions could be resolved fairly quickly if the trade
discussions in Washington (May 8-10) go well enough to allow the White House to
back off threatened new tariffs with another postponement.
Despite the recent posturing, the baseline belief is that both Presidents Trump
and Xi are champing at the bit to reach an accord and that once it is
announced, risk assets will see more upside. However, there has been so much
anticipation of a sweeping trade agreement that the actual deal announcement
may become a ‘sell the news’ moment. That would particularly be the case if the
deal is judged to be less than favorable for the US. But for now, as long as
talks don’t break down entirely, markets probably won’t price in a lot of
downside risk.
Ultimately, it may be a weaker Chinese economy that becomes the next dampening
effect on risk appetite. Amid the economic softness brought on by the US trade
conflict, Beijing has been ramping up stimulus efforts again. That has
translated into some improved economic data points in recent weeks, but
stimulus is only a temporary fix for the drag that a full rework of the
US/China trade relationship could have on China’s economy.
In the longer term, the trifecta of demur monetary policy, improving growth and
favorable resolutions of trade disputes could secure a prosperous economic and
trading environment for several years to come. However, when running for the
roses, be cognizant of the thorns.
CALENDAR
MAY
1: US ISM Manufacturing; FOMC Policy Statement & Press Conf;
China Caixin Manufacturing PMI
2: UK Manufacturing PMI; BOE Policy Statement
3: UK Services PMI; Euro Zone CPI estimate; US Payrolls & Unemployment
5: China Caixin Services PMI
6:
7: China Trade Balance
8: ECB Minutes; China CPI
9:US PPI
10: UK GDP; UK Manufacturing Production; US CPI; Preliminary Univ of
Michigan Sentiment
13:
14: UK Unemployment; China Industrial Production
15: Euro Zone Flash GDP; US Retail Sales
16: US Housing Starts & Building Permits; Philadelphia Fed Manufacturing
17: UK Retail Sales
20:
21: German ZEW Economic Sentiment; UK Inflation Report hearings
22: German Ifo Business Climate; UK CPI; FOMC Minutes
23: Various European Flash Manufacturing & Services PMI; European
Parliamentary elections (May 23-26)
24: US Durable Goods Orders
26: France holds EU Parliamentary elections
27:
28: US Consumer Confidence
29:
30: US Q1 GDP; China Manufacturing & Non-manufacturing PMIs
31: German CPI; US Core PCE; US Personal Income & Spending; Chicago PMI
JUNE
1: Hurricane season begins
2: China Caixin Manufacturing PMI
3: UK Manufacturing PMI; US ISM Manufacturing PMI
4: Euro Zone CPI Flash Estimate
5: UK Services PMI; ISM Non-manufacturing PMI
6: ECB Policy Decision & press conf
7: US Payrolls & Unemployment
10: UK Q1 GDP; UK Manufacturing Production
11: UK Unemployment; US PPI; China CPI
12: US CPI; China Trade Balance
13: UK Retail Sales; China Industrial Production
14: US Retail Sales; Preliminary Univ of Michigan Consumer Sentiment
17:
18: German ZEW Economic Sentiment
19: UK CPI; FOMC Policy Statement & press conf; BOJ Policy Statement
20: BOE Policy Statement; Philadelphia Fed Manufacturing
21: Various European Flash Manufacturing & Services PMIs; German Ifo
Business Climate
24:
25: Semiannual OPEC meeting (June 25-26); US Consumer Confidence
26: US Durable Goods Orders
27: US Final Q1 GDP
28: UK Final Q1 GDP; Euro Zone Flash CPI Estimate; US Core PCE Price Index; US
Personal Income & Spending; Chicago PMI; G20 Meeting in Osaka (28-29th)
29: China Manufacturing & Non-manufacturing PMI
30: China Caixin Manufacturing PMI
