Major central banks have had a busy start to the year
The first quarter of 2019 has so far seen risk assets rally significantly, in stark contrast to the final quarter of 2018. But while there is no doubt prices have rallied, we have not seen fundamentals improve in tandem with markets. The US dollar is close to flat on the year, US real rates have dropped, but not by much, and the oil price has spiked by more than 20 per cent. This combination of factors is unsettling against a backdrop of renewed bullishness in risk assets. Further, the global growth fears that presented themselves back in 2018 have not abated.
Central bank action
At the end of last year, we posited that growth fears may necessitate policymakers to once again intervene to get global growth back on track, and this appears to be playing out. The world’s three major central banks have been busy so far in 2019, but how long markets respond positively remains to be seen. If the European Central Bank’s recent efforts don’t have the desired effect, it could be an indication that this phase of the game is almost up.
The US Federal Reserve has further moderated its pace of rate hikes and returned to data dependency, effectively hitting the “pause” button on the hiking cycle.
After tighter financial conditions bit late last year, this pause has been a signal for risk assets that the party is back on and even US high-yield, an area of concern late last year, has posted strong returns to date. But if investors were fully convinced by the risk-on trade, traditional hedging assets like US treasuries and gold would have taken a hit by now.
This hasn’t happened, and is evidence supporting the argument that markets aren’t fully on board with the risk rally and are hedging their bets accordingly. While the tailwind of a dovish Fed has been clear to see, it is unlikely markets will be so kind if it hits “play” again and surprises with more rate hikes than those priced in already.
Boost for China
After a very weak 2018 which saw China deliver poor stockmarket performance and its worst annual growth figures since 1990, the story has taken a better turn so far in 2019. In advance of the National People’s Congress, markets priced in what was announced; namely accommodative monetary policy and aggressive fiscal stimulus, including major corporate tax cuts.
On the trade war front, headlines suggest the US and China are getting closer to a deal, but it’s clear that the issues between the world’s two largest economies run much deeper and investors should not lose sight of the fact trade accounts for roughly 4 per cent of GDP, while infrastructure spending pushes 20 per cent. While the conference announcements and trade talks have provided at least temporary tailwinds, what hasn’t happened is a commitment to the “big bang” stimulus, as seen in 2008 and 2015. If that is what the market has grown to expect when growth falters in China, the risks of disappointment are very real.
Mixed European picture
In Europe, we have seen Germany falter and narrowly avoid a recession through government stimulus, but Italy hasn’t been so lucky and is firmly in the throes of recession.
Compared to the Fed, the ECB has far less ammunition in its monetary arsenal, given it is still in negative interest rate territory.
But that hasn’t stopped it from trying, with ECB president Mario Draghi pushing back the first post-crisis rate hike and launching a third round of targeted long-term refinancing operations. These are effectively credit facilities that allow banks to fund loans they extend to the real economy at very low rates of interest, with this round helping banks roll over existing TLTROs and avoid a cliff edge in June that would have been likely to hit Italian and Spanish banks especially hard.
Given Europe’s especially weak position, it may be the unfortunate bellwether of whether markets are going to continue buying dovish policy as a panacea for weak growth.
With markets increasingly looking to be driven by policy, and after a decade of easy money, it may be time to begin questioning the sustainability of this. If Europe’s recent efforts don’t work, what next?
Bill McQuaker is portfolio manager at Fidelity Multi Asset Open funds