The broad-based rally in risk assets characterising most of the first quarter has continued despite global growth fears, putting the spotlight on central banks once again. But for central banks to step in with more meaningful stimulus that would encourage markets to keep the risk party going, the economic data may have to get worse first.
Narrow ‘goldilocks’ path for the US
At the end of last year, we pointed to global growth fears that would likely require policymakers to intervene further to get global growth back on track, and this appears to be playing out, with all three major central banks enacting supportive policy in 2019.
The US Federal Reserve has hit the pause button on their tightening cycle, and in the wake of tighter financial conditions which hit markets late in 2018, this pause has been interpreted by markets as a positive for risk assets. But the performance of traditional hedging assets, such as gold and US Treasuries, indicates that investors haven’t fully bought into the risk-on story, and are hedging their bets.
While the tailwinds provided by a dovish Fed are clear to see, and are indeed priced into the market, we fear the US economic data may continue to deteriorate. Even if markets are wrong on that, they are vulnerable to a hawkish surprise, which could come from continuing economic strength. From this starting point the ‘goldilocks’ path looks narrow to us.
China: missing the ‘big bang stimulus’?
In 2018 China posted its worst annual growth figures since 1990, and stock markets performed poorly. But this year has seen a reversal in fortunes for equities. A sentiment boost from positive signs on a temporary trade truce with the US has helped, but it is worth remembering the vastly more important role of infrastructure spending by the Chinese government.
On this front, the recent National People’s Congress saw some meaningful fiscal stimulus announced, as well as continued accommodative monetary policy. But this is all a far cry from the ‘big-bang’ stimulus seen in recent years. Have markets priced in a ‘big-bang’ that won’t come?
ECB: minimal ammunition
Meanwhile, the situation in Europe is troubling, with Germany narrowly avoiding a recession through government stimulus, while Italy is in recession. But the European Central Bank didn’t begin hiking when they had the chance, and now has minimal ammunition left given they remain in negative interest rate territory.
In recent weeks, they have certainly tried to intervene, with outgoing ECB President Mario Draghi delaying the first post-Eurozone crisis rate hike and embarking on a third round of Targeted Long-Term Refinancing Operations (TLTRO), allowing banks to fund loans they then extend to the real economy at very low rates of interest.
Helping banks, especially in the Euro periphery, roll over their existing TLTROs will help them avoid a so-called cliff edge. But this is all more damage control than stimulus, and markets have not responded as the ECB may have hoped.
It is likely that we will get some clarity on the longer-term direction of markets in the coming weeks, but in the meantime, we are closely watching corporate behaviour, as how corporate decision makers position their businesses goes a long way to shaping economic outcomes.
We are also focused on the direction of central bank policy. For how long the doves remain in vogue remains to be seen, but markets have built up a tolerance for the drug that is easy money and weaning them off will be no easy task.
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