Themes from JCRA’s annual economic overview
China is slowing, but we are unlikely to be headed for a global recession
- Market concern about a slowdown in China is rather misplaced. Domestic slowdown will bottom out soon and the trade war between the US and China will reach a truce with a resolution that will save face on both sides.
Should markets take Jay Powell’s dovish volte-face to heart?
- The Fed’s recent dovish statements indicated fewer rate hikes this year than were previously expected and the short end of the yield curve has fallen accordingly. But there is a genuine risk that the Fed may end up behind the curve.
- Continued strong consumer spending on the high street supports a good growth story and so does wage growth. For the last 30 years, hourly earnings growth has been one of the most consistent predictors of Fed monetary policy. It is now rising sharply. This will exert pressure on inflation and may force the Fed into another U-turn.
European growth – green shoots, but not much fruit
- After a promising 2017 in which Eurozone growth significantly exceeded expectations, 2018 was not a shining point.
- Germany and Italy fell into technical recessions in Q4 2018, and exports have been hit by Brexit.
- Nevertheless, unemployment continues to fall and wage pressures are building.
- There is a small risk that the resulting inflationary pressures may prompt the ECB to finally raise rates towards the end of 2019.
Brexit clouds continue to dominate UK business sentiment
- Spending delays and the associated suppression of GDP growth have been the most visible impacts of Brexit on businesses to date.
- On the positive side, this has resulted in businesses hoarding cash, which may fuel short term spending once more clarity is provided on the terms of the UK’s withdrawal.
- The anticipated benefit of a weaker currency has not materialised in export figures, largely due to sterling’s fall not being fully reflected in end prices.
- The central case scenario is a “soft Brexit” style deal is struck – but only at the final hour before the deadline.
- A soft Brexit deal would significantly increase the probability of one (possibly two) rate hikes from the Bank of England in 2019.
G10 currencies – from divergence to convergence
- 2018 was a story of USD strength, as the US economy and interest rate outlook powered ahead and diverged from the other main economies.
- In 2019, “convergence” is likely to be the buzzword, with the US fiscal stimulus starting to run out of steam and other economies catching up.
- Historically, the USD has tended to depreciate under these circumstances.
- Current costs to hedge future sales of USD are very high, and these will fall as buoyancy is removed from the currency, which bodes well for both EUR and GBP strength against the dollar.
In summary, a fairly positive outlook and certainly not the recessionary viewpoint reported by the broader media. That said, risks remain. The Fed may end up behind the curve on its tightening of monetary policy and the market could be taken by surprise if rate hikes from the ECB and the BoE occur later in the year.