Key points from around the globe:
1. Monetary policy
Most if not all sell side banks have abandoned their forecast for a Fed rate hike for 2019 and lowered their projections on Treasury yields. Even though the US economy is in good shape with no immediate threat of a recession and global growth should start to re-accelerate as we move through 2019 driven primarily by China, the market has started to price in rate cuts that won’t actually happen in the medium term. Markets tend to price in rate cuts further out in time (as we saw in 2006). Our base case remains for very patient and accommodative central bank policy which coupled with better Global growth, is bullish for Equities and Credit. In time this should help yields on the long end move higher.
2. US Economy
The US economy remains solid, with a strong US consumer and easy financial conditions. New home sales in the US last month were better than expected and consumer sentiment remains elevated. We think that lower longer term rates could stimulate the housing market and a healthy US consumer could drive purchases of new homes. Having said we still believe the growth of 2018 was a peak and we will continue to see patches of weak US data (in retail sales, manufacturing activity etc..) coming out in first half of 2019. However we are by no means calling an end to the current cycle and in fact believe the cycle will continue into 2020.
Encouraging manufacturing data out of China this week shows some early signs of economic stabilisation. We believe that there will be a second half 2019 cyclical recovery in China which will drive global growth along with it. Companies that are geared towards the China growth recovery, including Energy, Materials, Metals, Chemicals and Autos, will benefit from this. The Chinese government remains committed to stimulating the economy through a combination of traditional and unconventional measures. We remain patient on China until we start to see further signs of stabilisation before committing capital. We expect other regional data to start confirming the upturn in Chinese activity in the coming weeks.
In a bid to protect the Turkish Lira from depreciating, right before a crucial municipal election, the Turkish government engineered a currency crunch whereby a huge spike in overnight swap rates made it too expensive to short the Lira. This spilt over to Turkish bonds and stocks amid fears that the government was bleeding through their FX reserves to defend the currency. Since Turkey borrows a substantial amount in external currency, and has $2.9billion in debt maturing this year, market is worried this could create a solvency problem. The grander problem here though is uncertainty over policy and government intervention in markets which could lead to a broader loss of investor confidence in Turkey. How much power has slipped from Erdogan’s hands remains to be seen, but we believe that shorter term Turkish hard currency debt is mispriced and presents a buying opportunity. Any risk beyond this whether in longer term debt or stocks is best avoided until we see more political clarity.
Uncertainty over the new government’s ability to pass essential reforms has been an overhang on Brazilian assets. The Bovespa, Brazils’ broadest stock index, has already corrected 8.5% since its all-time peak in March. President Bolsonaro’s first few months in office have showed some promise on the economic front (responsible monetary and fiscal policies, following up on infrastructure plans announced by former president Temer and putting together a plan for pension overhaul), but have brought to light friction on the political front. Bolsonaro has an erratic relationship with congress which could delay or even halt reform measures. The most crucial of these is the Pension reform which will be presented in August. We remain cautious on Brazil and will only pull the trigger should we see some progress on passing these measures.
Europe continues to be a weak link in the global economy, with downside risks intensifying. Germany just printed the worst manufacturing performance measure in seven years. Euro area core inflation came in at its weakest in 11 months. Italy’s industrial contraction is getting worse and overall Euro measure of confidence and demand is at multi-year lows. This is forcing the ECB to maintain a very accommodative approach to policy in order to stabilise prices. Encouraging data from Asian economies, especially China, and positive outcome from the US-China trade talks, should in turn help Europe to bottom out though the lag could be a few months. We remain on the sidelines when it comes to European assets but our base case is that we should start to see an economic turnaround in European data in second half of this year which could attract inflows to European markets.
As the prospect of a long extension dawns again, it appears that complacency will once again set in and the infighting on what type of Brexit will re-intensify rather than MPs coming closer to the solution. With Theresa May committing to go and Europe getting impatient, a new election is quickly becoming a base case as a step to resolving this issue. However it is uncertain whether even that yield any clear verdict or be supportive of Sterling. The overhang on UK economic activity continues and should continue to pressure the relative performance of UK assets.
We believe US stocks are fairly priced, and perhaps not reflecting fully the downward revisions in corporate earnings, and we don’t see significant fundamental upside from here. Credit spreads remain tight with more downside risk however we expect them to remain stable over the near term. Our preference is for shorter dated IG securities in select sectors and a neutral position on US stocks until we get a better entry point. Should US data show signs of strengthening pushing longer term rates higher and the market prices in potential rate cuts down the line sending short term rates lower (essentially a steepener) we would favor going longer duration. When it comes to Europe we see the spillovers from China and an easier fiscal policy to drive some performance, but there really is no clear cut case for overweighting Europe in portfolios currently. If stronger fiscal action is taken, possibly in the latter half of 2019 after the European elections, a stronger case for Europe could be made. The most attractive potential opportunities will be in select Emerging Markets of which China could be very attractive amid a cyclical recovery.
Overall, central bank dovishness has caused yields to drop substantially from last year which is reigniting the search for yield theme that has dominated markets for so long. The risk premium investors are demanding to own EM debt for example, is on average 50 basis points higher than a year ago even though growth is accelerating vs. developed nations. The case for EM assets is getting stronger, driven by Fed and ECB policy and stimulus in China. Being selective is important though and we would avoid the more turbulent areas of EM like Turkey and Brazil until the dust settles but we see an acceleration of EM into year-end albeit in a volatile market.
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