Introduction
The beginning of 2019 was, in some ways, similar to the several years before—the market expected the rest of the developed world to join the US in policy tightening and see a reduction in quantitative easing (QE). Perhaps due to the US/China trade spat, Brexit, EU budgets, and the like,the focus on slower global growth has engendered a more reserved approach by both businesses and consumers. However, like before, that expectation hasn’t panned out. Some central banks are threatening rate cuts to balance lower growth and weaker inflation, others are waiting to see if the world’s gloomy downturn has been overdramatised. The US Dollar has been a strong market contender, often rising on account of its safe-haven allure, while emerging market currencies have been weakening. Not surprisingly, the most often quoted pearl from the asset management industry is ‘we are being very discriminating with asset selection’. Meanwhile commodities such as oil have been rising higher; a continuation of this surge could have a negative inflationary element in the long-run, giving some central banks a headache in the quarters to come.
EUR
The third-largest Eurozone economy, Italy, has had some bad press in recent years. There’s still no resolution to the ongoing banking problems, politics are shaky, and Italy’s growth forecasts suggest there will be almost no expansion this year. The positive by-product of this circumstance is that European Central Bank (ECB) interest rates should remain lower for longer, and in turn, keep Italian funding at tolerable levels as well. With positive ecostats flowing out of China and optimism that German manufacturing will stabilise as a result, Italy may find funding costs rise before any resultant economic benefits wind their way through the system and balance the picture somewhat. Funding is a fragile thing in the post-Global Financial Crisis epoch.
EUR outlook
At the time of writing, US/China trade negotiations are still ongoing, but Donald Trump has already determined the next target of his trade term improvement platform will be the EU. Germany, the largest economy in the EU, has experienced a marked decline in manufacturing as a consequence of its close economic ties with Chinese manufacturing. Trump’s first strike was aimed at EU car imports to the US, and as Germany is a key manufacturer, it now has cause for concern on yet another front. It seems a resolution on US/China trade could support the EU but open up a more direct and damaging attack from another avenue.
While core Eurozone economies have taken a downturn, there has been an uplift in periphery fortunes. Although they contribute a small combined total of EU growth, this tilt has narrowed an economic chasm that has been widening since the GFC first took hold in the bloc. If German core fundamentals stabilise, there’s the potential that the European Central Bank will accelerate its monetary policy tact and the EU may find all oars pulling together for the first time in a decade.
On that note, it’s worth bearing in mind that ECB Chief Mario Draghi will be stepping down at the end of October after an eight- year term, and it’s going to be challenging to find an experienced replacement to lead the monetary policy-setting council for 19 member states. A new Chief will bring their own approach to policy direction, which will have a direct impact on Euro growth. The lens is also shifting to the EU elections where a populist surge could cause some more uncertainty for the Euro. Jean Claude Juncker and Donald Tusk, who have played such key roles in the political and economic direction of the bloc, will also be stepping down at the end of the year. With so many persons at the centre of EU politics and policy for the past decade exiting the scene, the potential for a dramatic change for bad or good is clearly present.
USD
For the past several years, the Federal Reserve—due to singular US economic performance—has been gradually tightening monetary policy. The expectation for some time has been that the rest of the developed market (DM) economies would likewise return to growth and join the upward interest rate trajectory. In the past quarter, the Federal Reserve surprised markets by pausing policy tightening. This so-called ‘Fed Pivot’, caused longer-term borrowing rates to fall below short-term rates, a classic sign of impending recession. The rationale for this change is unclear but is probably due to three factors: slowing global growth, a persistently strong US Dollar—the world’s reserve currency, and reflation of energy prices towards pre-2014 levels. However, on the other side of the pivot, there’s been strong US economic data—including recent Non-Farm Payrolls numbers. If ecostats continue to impress and China and the US can form a trade resolution, there’s a chance this could just be a pause before the Fed chooses to hike again, because all things considered, the US hasn’t had a terrible start to 2019.
Viewed from a political angle, the Fed has been quite reliable with its forward guidance in the past five years, but now the guidance has changed to ‘data dependent’, which means ‘wait and see’. This is probably a reflection of the change in approach by central bank Chief, Jerome Powell, who took over from Janet Yellen in February 2018. Despite being picked by Trump, Powell has faced a lot of criticism from the President since his instalment for continuing his predecessor’s policy tightening path.
Many central bankers have been alarmed by Trump’s unwarranted intervention into the Federal Reserve—a traditionally technocratic institution. The ECB’s Draghi weighed in, concerned about the Fed’s independence, and suggested that a loss of autonomy would undermine its credibility. While Trump can’t sack Powell, he can put pressure on him to leave; should the Fed choose to hike rates ahead of the 2020 elections, Powell could find himself under an immense amount of pressure.
USD outlook
The US Dollar is expected to remain quite buoyant against a backdrop of unresolved political developments and sluggish global growth. However, the next US Presidential Election is less than 18 months away, which means the campaign season is drawing very near. One thing seems clear: Donald Trump needs to wrap up his China trade negotiations before the autumn to establish a strong foundation of accomplishments in his first term and gain his best chance for re-election for a second term. This provides at least another quarter of potential dithering before a trade resolution can alter global growth perceptions and undermines the up- to-now, dominant US Dollar.
