The US Federal Reserve’s move away from rate hikes and improving economic conditions in China triggered dramatic upswing in global markets in early 2019 unlike the volatility spikes witnessed in late 2018. Trade wars, Brexit and European and political risks in the US are key factors that can drive volatility and threaten risk asset prices in the coming months.
Investors will need to work harder for risk-adjusted returns than they have done for the majority of the post-financial crisis period. Below are some of the opportunities and risks we see across asset classes and markets in the coming months.
China’s economic stabilization should drive increased investment there. According to the IMF, China is expected to drive 33% of global GDP growth in 2019, and is on track to surpass the US as the world’s largest economy by 2030. China could surpass Japan as the world’s second largest bond market. The US Fed’s decision to hold off on further rate hikes puts it in closer alignment with generally dovish central banks globally, which should help carry strategies to generate positive contributions to total returns for the remainder of 2019.
Global economy bends, but doesn’t break
The Purchasing Manager Indexes (PMIs), which remain above the 50 line separating expansion from contraction are now signaling somewhat below trend growth. Our base case for coming months is that the global PMI will stabilise above 50, implying a soft landing for the global economy.
China’s easing of monetary, fiscal and regulatory policy is helping to cushion its economy. Credit growth has rebounded and infrastructure investment is showing signs of life. Ongoing trade uncertainties create risks for business confidence, but we expect some de-escalation given incentives on both sides to avoid unacceptable economic and market weakness. Other emerging markets and developed markets like Japan and Europe have the potential to outperform.
An extended economic cycle
With the US economic expansion, poised to become the longest in the US history, investors are cautious on how long the expansion would continue. The Fed has now shifted focus to the stubborn downside misses of inflation to its 2% target over the last decade. This has led to increasing discussion of the Fed’s strategic framework and whether the central bank needs to rethink on its policy.
Risks to the base case
Risk assets have priced in much of the good news from these tailwinds. This leaves markets vulnerable to negative developments. Trade policy risks remain. Another concern is that the China stimulus is targeted at its domestic economy. Indeed, China’s stimulus is focused on boosting consumer confidence and small and medium enterprises. An unbalanced growth can be a cause for concern because if it continues alongside a US economy which is outperforming, the already expensive dollar could strengthen further. This could weigh on US corporate earnings and cause disruption for emerging markets, creating a potentially negative feedback loop.
The author is head- FX Risk Solutions Karvy Forex & Currencies Pvt. Ltd