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Themes to Watch in 2019

    

VT_2019

Themes to watch in 2019: Mixed Bag in Asia, What Next for the Fed? Deal or No Deal? Critical Times for Britain

Mixed Bag in Asia

There are some signs that Asia’s fortunes could turn around in 2019.  The strength in the U.S. dollar has hurt Asian markets this year, however there are some small signs that the trend may change in 2019. 

The major factor is the actions of the U.S. Federal Reserve.  After much ongoing debate about the Fed’s plans for rate rises, the Fed is expected to slow the rate rises for the new year as growth in the U.S. is expected to slow down. 

The other major issue is the ongoing trade war between the United States and China.  Many Asian economies have supply chains that are linked to China and are heavily dependent on trade.  However a lot of the negativity from the U.S. - China trade war has already been priced in by markets, which is why Asian stocks have been sold off so much in 2018.  With the 90-day “ceasefire” currently in place between Washington DC and Beijing, it is likely Asian stock markets will start the year consolidating. 

There could be further downward pressure on the U.S. dollar with the United States facing current account and fiscal deficits.

Jonathan Garner, Morgan Stanley's chief equity strategist for Asia and emerging markets believes that Asian markets have hit the bottom and will likely turn around in 2019 due to China's expansionary monetary policies to help spur economic growth.  "The Chinese monetary cycle is diverging from the U.S. monetary cycle," he said.   

In an interview with CNBC, Mr. Garner said that broadly for the markets, "that's got to be positive when China is easing."  He believes Asian markets have already "reached their troughs" in late October or early November and that he is "outright bullish on markets out here" in the region.

Meanwhile, a survey has shown that top finance executives who operate in China are losing confidence in China's economy.  According to the results of a survey by Deloitte, mounting trade risks are dragging down the confidence of senior finance officers.

Twice a year the Deloitte polls financial executives about their attitudes on trade and business for its China CFO Survey.  Significantly, 82% of respondents said their economic outlooks had become less optimistic, when asked to describe changes in sentiment over the past six months.  Only six months ago just 30% indicated they were less optimistic. 

William Chou, national managing partner of the Deloitte China CFO Program said, “There has been a sharp shift in sentiment".  He cited factors including China's struggling stock markets and a lack of progress with the ongoing trade wars between the United States and China. 

China’s struggling stocks have been blamed in part on the ongoing trade war.  Earlier this month, U.S. President Donald Trump and Chinese President Xi Jinping declared a 90-day ceasefire in the conflict pending further negotiations.

The Shanghai composite and main Shenzhen index are down more than 20% and 30% respectively in 2018, which places Chinese stocks among the worst performers globally.  The markets will be watching the first three months of 2019 closely, as this will hopefully bring much needed clarity on U.S. - China trade tensions.

However, a trade deal between the world's two largest economies is far from certain, especially after Chinese President Xi Jinping took a relatively defiant tone toward international demands in his key address to the nation recently. 

The Deloitte survey also indicated what could be a boost for the rest of Asia.  59% of the respondents believed that trade volumes will decline in 2019, with many of them being affected by rising tariffs.  53% of the respondents indicated that Southeast Asia would see the largest increase in export volumes. 

In explanatory notes from the survey, Deloitte said, "Southeast Asia has been developing itself as a manufacturing hub and the changes may provide it unforeseen opportunities.  The region may also benefit from companies shifting manufacturing capabilities to avoid some of the trade protectionist measures."

Specifically addressing China's currency, 74% of respondents said they expect the yuan to weaken further against the dollar in the coming year.

 

What Next for the Fed?

There has been much conjecture in 2018 about the best path for the United States Federal Reserve (Fed) to follow with their monetary policy.  One thing for certain however is that the Fed have been very transparent about their own views and plan.

As widely expected, the Fed raised its benchmark interest rate a quarter-point to 2.5% in December, but lowered its projections for future rises.  The latest rise was the fourth increase this year and the ninth since it began normalizing rates in December 2015.  It also came despite U.S. President Donald Trump's strong public comments against further rate increases at this time.  Leading up the latest rise, he said "it is incredible" that "the Fed is even considering yet another interest rate hike." 

Fed officials now project two rate rises next year, which is a reduction but still ahead of current market pricing of no additional moves next year.  The latest Fed move and subsequent comments fueled further concerns about slowing global growth.  The U.S. central bank signaled "some further gradual" hikes.  It was unlikely that the Fed was ever going to completely remove reference to rises in 2019, however many expect that they will remain data dependent as we go into 2019. 

The Fed assured that it will "continue to monitor global economic and financial developments and assess their implications for the economic outlook."

Talk continues to dominate market commentary that the Federal Reserve have softened their stance and may not raise rates throughout 2019 as they have been hinting at for some time now.  Even though they strongly hinted at the December rate rise, the central bank has hinted that an interest rate rise is not as certain for 2019. 

Recently Federal Reserve governor Lael Brainard spoke at an event in Washington, and said the economic picture was broadly positive but that risks were growing in the corporate debt markets at home and overseas.  “The gradual path of increases in the federal funds rate has served us well by giving us time to assess the effects of policy as we have proceeded," she told the audience. "That approach remains appropriate in the near term, although the policy path increasingly will depend on how the outlook evolves.”

Fed Chair Jerome Powell confidently stated that the U.S. economy remained “healthy” and “solid” and said he did not see any reason to sharply change the Fed’s path of gradually pulling back support for it.  However significantly he acknowledged the economy is showing signs of “softening” and there is a “fairly high degree of uncertainty” about what the Fed will do.

In doing so, Powell confirmed concerns that the U.S. economy is slowing and has scaled back its plan to raise interest rates in 2019.  The Fed lowered its 2019 growth forecast from 2.5% - 2.3% and indicated it is likely to do only two interest-rate hikes in 2019, down from its earlier forecasts of three increases.

Powell himself said that while a weakening of global growth and recent market turmoil might signal some softening of conditions relative to the Fed’s expectations a few months ago, the magnitude of the shift was relatively small.  "In our view these developments have not fundamentally altered the outlook,’’ he said.

After the most recent rate rise, markets fell sharply out of concern that the Fed may not be adequately reacting to the risks facing the global economy.

U.S. President Trump has previously urged the central bank to stop raising interest rates, calling them “foolish” and “crazy” for raising rates when there is little sign of inflation.  With U.S. stocks set to have their worst year in ten, President Trump has blamed Powell for the stock market slump in recent months. 

President Trump has some allies in this debate, however.  A growing number of business leaders and economic forecasters believe that a recession is coming in 2020 yet the Fed is operating as if there are few problems ahead. 

The central bank has lifted rate four times this year, the most since 2006, and several prominent Wall Street investors have criticized Chair Powell, saying the Fed has raised interest rates too much this year and should hit the pause button.

Since Powell took over the Chair role at the Fed in February 2018, U.S. stocks have dropped after every Fed decision, with his words and actions failing to calm markets.

Like most of his predecessors, Powell says his main focus is economic fundamentals, not short-term market whiplash.  “A little bit of volatility … doesn’t probably leave a mark on the economy,” Powell said.

 

Deal or No Deal?  Critical Times for Britain

Of great interest to those in Europe, and with the United Kingdom due to leave the European Union (EU) on 29th March 2019, markets are watching closely as to what deal the UK can strike with the EU.

The British government published a report that quite clearly declares that its plan for leaving the European Union will be bad for the economy.  The report outlines the economic costs associated with a range of Brexit scenarios.

Under all scenarios studied by the government, the UK would be worse off.  Government officials did not estimate the precise impact of the deal Prime Minister Theresa May has negotiated with the European Union, however even the best case scenario will mean a weaker economy than remaining in the EU. 

Whichever way you look at it, the official government report doesn’t paint a pleasant picture. 

"It is true that the economy will be very slightly smaller, but if we do the deal in the way that the prime minister has set out and negotiated, that impact will be entirely manageable," UK Treasury chief Philip Hammond said in an interview. 

"If you look purely at the economics, remaining in the single market would give us an economic advantage," Hammond said.

A day after the British government’s report, the Bank of England (BOE) followed with their own assessment.  In a blow to supporters of Brexit, the BOE has said Britain risks suffering an even bigger hit to its economy than during the global financial crisis 10 years ago if it leaves the European Union in a worst-case Brexit scenario in a few months' time. 

The BOE published an assessment of different scenarios related to the U.K.'s withdrawal agreement from the EU and made the claim that a "disorderly" exit from the European Union would plunge the U.K. economy into that position.  In the "disorderly" scenario, the U.K. "loses existing trade arrangements that it currently has with non-EU countries through membership of the EU."

The central bank added that "the U.K.'s border infrastructure is also assumed to be unable to cope smoothly with customs requirements."  The bank also outlined the impact of a "disruptive" Brexit scenario that would see unemployment rise to just below 6 percent.  

"Our job is not to hope for the best but to prepare for the worst," BOE Governor Carney told a news conference, noting that Britain's banks could cope with the worst Brexit shock.  Carney defended accusations that he was spreading panic. 

"Parliament has demanded this analysis," he said. "It's not supposed to make people scared, it's supposed to provide reassurance that, even if this happened, which is not likely, the system is more than ready for it."

Deputy Governor Ben Broadbent commented specifically on the GBPUSD, saying, “The fall (in sterling) since the referendum represents the market’s view on a range of possible outcomes. And essentially the larger the effect on UK trade, the UK exit, the further the sterling is likely to fall, for various reasons. So at the moment what is ‘priced in’ to the level of the exchange rate is a number of possible outcomes.  So if the eventual exit is towards the better end of that range, you would expect sterling to rise from here, if it’s towards the worse end of that range, you would expect it to fall further. And generally, the greater the economic dislocation, the worse the exchange rate is going to be, there’s a direct relationship.”

In the latest move confirmed in a statement by PM May to lawmakers in the House of Commons, a Brexit vote in U.K. parliament has been delayed by the PM, following fears that the British government was headed for an embarrassing defeat. 

“If we went ahead and held the vote tomorrow, the deal would be rejected by a significant margin,” she told parliament of the agreement she clinched after 18 months of tortuous negotiations.  With her position in jeopardy, PM May said she would now go back to the European Union and seek reassurances over the so-called Irish “backstop”, which is an insurance policy to ensure no return to a hard border on the island of Ireland. 

"I will hold emergency talks with EU leaders to discuss possible changes to backstop," May said before adding that Brussels were open to further discussions on the matter.  The U.K. leader defended her original proposal saying she was in "no doubt that this is the right Brexit deal." May also warned that those who wanted to promote a second referendum, must "be honest on the risk of dividing the U.K." 

The EU didn’t seem as enthusiastic for more talks as European Council President Donald Tusk said neither the withdrawal agreement nor the Irish backstop would be renegotiated.

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