The sell-off in risk assets at the end of 2018 was in part due to a Federal Reserve (Fed) seemingly on autopilot in shrinking its balance sheet and hiking rates. The ‘pivot’ to an early end to quantitative tightening and a ‘data dependent’ stance on rates has underpinned the subsequent rally in global risk markets (US & international equities, real estate) and falling bond yields.1
A defining feature of the first quarter and outlook for the rest of the year is the dramatic shift lower in market expectations for Central Bank policy rates and a partial inversion of the US Treasury curve. Critically, the Fed pivoted from signaling three rate hikes in 2019 to none and announcing the end of ‘quantitative tightening’ (the shrinking of the Fed’s balance sheet). However, the interest rate markets may have overshot on pricing cuts in Fed policy rates starting this year. As wage growth gradually picks-up and approaches 4% in the latter part of the year, there very well may be a re-rating of the outlook for Fed rates.
But a simultaneous rally in bond and equity markets is unlikely to continue through the second quarter – either growth fears will ease and bond yields will move higher or equity markets will heed the growth warning from falling bond yields.
The resilience of the US dollar, despite the Fed’s dovish pivot, reflects confidence that US growth will outperform and worries that Europe is on the brink of recession. But like the Fed, investors should be patient. Most of the slowdown in Europe was imported from China and the decline in global trade. Policy stimulus started in late summer 2018 from Beijing is set to stabilize Chinese growth, solid domestic demand and an European Central Bank determined to keep financial conditions easy, the economic gloom hanging over Europe is likely excessive.
The US presidential election campaign is effectively underway being the third year of an incumbent’s first term is usually very stimulative to the economy. President Trump wants a trade deal ‘win’ with China - and likely to get, which will be positive for Europe and Emerging market equities. Brexit remains a tail risk but a prolonged extension and ‘soft Brexit’ is still the most likely outcome.
With interest rates anchored by dovish world central banks and global growth set to stabilize, focus instead on the flow of forthcoming economic data and corporate earnings.
“When it comes to relativeness between the economy and stock market, better or worse matters more than good or bad.” Liz Ann Sounders, Charles Schwab Chief Investment Strategist.
1Riley, David. “Asset Allocation Navigator: Second Quarter 2019.” Blue Bay Funds, us.rbcgam.com/resources/docs/pdf/HTML-files/web/AssetAllocationNavigator_2Q19.pdf.
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