Global equities end Q1:2019 on a soft note, as Government bond markets signal elevated recession risks
Global equities increased in the past week, ending March up by +1% mom (+12% in Q1 – see our Quarterly Asset Scoreboard on page 3) and surmounting several factors including: i) weak economic data, particularly in Germany; ii) concerns regarding the inversion of the US Treasury yield curve; and iii) political uncertainty, mainly driven by Brexit developments.
Regarding global growth, actual data and surveys, so far, are sending mixed signals, failing to provide reassurance that economic activity is bottoming out. The euro area economic surprise index (CESIEUR) is deep in negative territory, with the Germany PMI manufacturing declining to 44.1 in March (a 7-year low). The US economic surprise index (CESIUSD) remains also below 0, suggesting that actual data releases are coming broadly below consensus expectations, albeit improving, with the ISM manufacturing increasing to 55.3 yesterday vs 54.5 consensus. Q1:2019 US real GDP is expected at a trend-like 2%, according to the Atlanta Fed Nowcast model.
Finally, the latest round of Chinese PMI data (above 50 for the first time in 4 months -- see Economics) offered a more optimistic view, albeit caution is warranted due to possible positive effects stemming from the New Lunar Year Holiday. Overall, the latest high-frequency Chinese data (credit, retails sales, FAI), due to be released in mid-April, will provide more clarity regarding the stabilization of economic growth.
Regarding yield curve inversion, investor concerns are understandable, since 7 of the 8 US 10Year/3month inversions (i.e. a negative spread between the two tenors) since the 1960s have been followed by a US recession, with an average lag of 11 months (min: 6 months I max: 17 months – see graph below). Albeit the inversion should not be ignored, there is evidence that the recession signal may not be so robust this time due to specific factors such as i) negative US Treasury term premia due, inter alia, to global Quantitative Easing; and ii) negative nominal bond yields in Germany and Japan, which raise the attractiveness of US Treasuries, thus holding down the long-term USTs.
Two critical factors could support the global economy in H2:2019/H12020 and, thus, risk assets (i) if US-China trade developments conclude positively and (ii) if the Fed’s dovish turn since January (0 interest rate hikes are now expected in 2019 vs 3 in December 2018) could reverse the over-tightening of 2018 comprised by four interest rate hikes and $373bn liquidity deletion. Recall that in the past, episodes of yield curve inversion were driven mainly by a larger increase in short-term interest rates compared with long-term ones (bear-flattening), as the Fed was hiking to combat an overheating economy, rising inflationary pressures and/or financial imbalances.
Regarding political uncertainty, following the rejection of eight motions last week (and another four on Monday) on the future of Brexit by the British Parliament, options now appear limited. Should Parliament fail to agree, general elections or a request for a longer extension to Brexit appear possible scenarios. In the US, Special Counsel Mueller found that the Trump administration did not conspire with Russia in the 2016 elections, but Mueller drew no conclusion regarding the obstruction of justice by the President. As a result, the Attorney General concluded that the President did not commit an obstruction of justice offense, minimizing the odds for impeachment.