A dovish Fed and optimism regarding trade improves risk sentiment early in 2019, following heavy equity losses in December
The Fed increased rates by 25 bps to 2.25%-2.50% in December 2018, sending equity markets down sharply. Policymakers lowered their estimates for future tightening, anticipating 2 additional increases in 2019 (vs 3 previously), while they continue to expect 1 hike in 2020. However, investors currently do not price in a hike for 2019 and expect a rate cut for 2020.
Following S&P500 losses of -8% following the December 19 FOMC meeting, the Fed signaled its willingness to pause its tightening for a few months, amid tighter financial conditions and modest inflation pressures. Looking forward, the Fed is likely in a “wait-and-see” mode, in view of market tensions and mixed data, with attention now on the FOMC meeting on January 29-30. US Treasuries have rallied by 20 bps relative to the pre-December FOMC meeting (2.65%).
The US federal government partial shutdown continues (currently: 25 days, the longest in US history), after the Senate failed to break an impasse over the President Trump’s demand for $5bn in funding to build a wall on the US border with Mexico. The shutdown has affected circa 800k workers, albeit half of them continue to work without pay. The impact on Q1:19 GDP (0.1% saar of GDP per week) could intensify if the shutdown persists.
Chinese policymakers acknowledged the downward pressure on the economy and signaled further stimulus for 2019, primarily through “significant” tax and fees cuts (Central Economic Work Conference, December 19-21). Monetary policy will supplement easing efforts (targeted RRR cuts on top of the recent cut of 100bps to 13.5%), but room for broad-based loosening appears limited, as policymakers try to strike a balance between deleveraging (while avoiding capital outflows) and an economic slowdown. (See our brief summary on the 2019 Chinese Economy on page 2).
Year-to-date, the positive sentiment for trade developments has largely prevailed over growth concerns due to weak economic data (Chinese PMIs, industrial profits, US ISM) and earnings worries (e.g. Apple negative guidance) with the MSCI ACWI up by +4% ytd (-11% in 2018), but still 5% below its early-December high.
Investors took comfort following Fed Chair Powell’s dovish comments that policymakers could make changes in their rate hike or balance sheet reduction plans. Markets advanced (4-10/1), as December’s US labor market report beat expectations, thus easing US growth fears. US corporates begin reporting Q4:18 earnings results on Monday (14/11) with Citigroup.
Corporate bond spreads have narrowed only modestly in most categories, ex US High Yield which has rallied by -80 bps ytd (but still 35 bps above its early-December levels), as the Fed appears eager to pause and oil prices have increased significantly (Brent: +13% ytd to $59/barrel).
The British Parliament will vote on the Withdrawal Agreement (WA) on Tuesday. There is a serious risk of a “no deal” and, if MPs reject the WA by a wide margin, the Labor Party will intensify its call for a vote of no confidence. The GBP/USD has appreciated by 2% to $1.286 since mid-December.