As 2019 gets under way, Europe is sliding back into recession despite a negative ECB policy rate.
Strains in the US credit market reached a crescendo in the first trading days of 2019, as Barclay’s high-yield spread climbed more than 500 basis points above US Treasuries. This combined with a bear-market run in equities from the September highs saw US Federal Reserve chief Jerome Powell trotting out the latest version of the Fed in an interview where he shared the stage with his two bubble-blowing predecessors. There was plenty of egg on Powell’s face as his promise to “listen to the market” came barely two weeks after he put on a hawkish show at the December 20 Federal Open Market Committee meeting. So the Fed is already slamming on the brakes as the flows from corporate repatriation run dry and high-risk issuers have not been able to auction debt.
China is still contemplating its next stimulus – tax cuts, mortgage subsidies, a stronger renminbi – and is wondering how to proceed towards its 100-year anniversary in 2049 with its 2025 plan now pushed back to 2035. The UK, meanwhile, has suffered the biggest credit impulse contraction of any country, leaving the first half of next year a major risk for UK assets.
One bright spot for the new year is that the price of energy in USD terms plummeted back to 2017 levels in Q4, though it remains very volatile. Still, it will take some time for this fresh stimulus to be felt after the highest prices since 2014 were registered a mere three months ago – particularly for emerging market currencies, which were likewise very weak at the time.
In Q1, a combination of the Fed pausing and signalling a climb-down from QT with China continuing to drive the CNY stronger toward 6.50 or better versus the USD could help. China can pay the price of a 5 per cent stronger currency as it reduces the burden on state-owned enterprises' USD-denominated debt and could power a massive boost in resolving the trade impasse. At the same time, a strong policy move like this from China with a weaker USD backdrop could drive a considerable relative revival in EM assets.
The global economy is suffering, global markets are shaken after a terrible 2018, and China will do all it can for stability. The hunt for a solution is fully engaged, and the odds of one appearing are rising fast. In our view, a solution needs to show itself before February 5, the Chinese New Year – this is a top priority for both sides in the US-China trade dispute. The alternative is simply too dire. After Chinese New Year, we will see powerful support for the Chinese economy – it is needed, and it will come. Nonetheless, beware of incoming turbulence as the policy response everywhere is reactive rather than predictive and may come a bit too late. This means that Q1 is the riskiest period, and this is where the cyclical low in assets and the economic cycle will come. Q1 may see a significant market low for this part of the cycle.
That being said, early 2019 could merely mark the start of the cycle or the early innings of the next cycle of intervention. 2020 is more likely to prove the real year of change. That would fit the political cycle, and it might take an even bigger scare for central banks and politicians to get their acts together – unfortunately.
Welcome to the Grand Finale of extend-and-pretend, the worst monetary experiment in history.