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Fed-driven recession; Fed tanks markets; Emerging markets dim outlook; Central banks slowly normalise; Brit interest rates stuck

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Here comes a Fed-Driven recession

By Peter Rosenstreich

Although the American economy is firing on all cylinders, with private consumption remaining the main driver and business investments growing steadily, US economic expansion outpaced most other advanced economies in 2018, giving the late stage business cycle a zombie-like movement. Overheating labour markets and rising inflation drove the US Federal Reserve to raise interest rates four times in 2018. This pushed financial conditions into restricted territory, with several cyclical indicators now pointing to a recession in 2019: forecasts suggest the Fed will raise interest rates by 0.25% three times. Yields on short and medium-term maturities have risen, but the overall result has been an extreme flattening of the yield curve – the most reliable indicator of recession risk. With the US economy accelerating and the President driving domestic expansionary policy, it is hard to image a substantial slowdown. Yet investors will position themselves more defensively, as downside risk for equities and credit markets will increase in 2019.

Fed sinks dollar and equities

By Arnaud Masset

The US Federal Reserve Bank yesterday lifted interest rates for the fourth time this year, but Chairman Jerome Powell suggested the pace of increase could slow down significantly in 2019. “The Committee judges that risks to the economic outlook are roughly balanced but will continue to monitor global economic and financial developments and assess their implications for the economic outlook.” In other terms, it means that the Fed will embrace a wait-and-see approach next year. The Fed is now expecting two rate hikes next year, compared to three suggested in September.

Markets were expecting a more dovish response from the Fed. After rising 1.5% ahead of the meeting, the S&P 500 collapsed 78 points and ended up the day down 1.54% at 2,506 points. More importantly, the Blue Chip index broke a key support (2,532.69 from 9 February 2018) as it closed at its lowest since October 2017. In FX, the greenback extended losses during both the Asian and early European sessions. EUR/USD rose 0.90% to 1.1480, while the Dollar Index gave up 0.75%. This is not the end of the sell-off, as the Fed continues to withdraw liquidity from the market at a pace USD 50 billion a month. The US economy has no choice but to deleverage.

Emerging markets at risk in 2019

By Peter Rosenstreich

Emerging markets were expected to be the big trade in 2018, coming off a slingshot of positive tailwinds in 2017. Rising commodity prices, faster growth, subdued inflation and strong risk appetite driven by loose monetary policy set the stage for a banner year. However, EMs suffered as a result of one negative development after the next in 2018. There is now growing divergence between developed and emerging economies. Countries with relatively solid fundamentals driven by commodity exports should continue to see growth improve. However, with higher yields in the US and rising energy prices, countries with high exposure to foreign debt, oil-importing countries and those with persistent macro-imbalances will find 2019 challenging.

Central banks slowly normalize

By Peter Rosenstreich

Central bank policy in 2018 may have created the perception of inaction. However, key banks were steadily tightening liquidity. The US Federal Reserve allowed USD 400 billion to run off its balance sheet. Having bought more than EUR 2 trillion in government bonds, the ECB will wind down monthly asset purchases to zero, from EUR 60 billion a month: that added 0.75% to GDP growth, supporting the upturn in Eurozone activity over the last three years. The Bank of Japan has conducted “stealth tapering” by holding monthly purchases below USD 60 billion. Finally, the Bank of England’s asset purchase facility remained stable at EUR 435 billion. The trend is for a deeper reduction of central banks’ balance sheets. Increased expectations for tighter financial conditions result in lower demand on fixed income markets and generate a ripple effect into other asset classes.

British interest rates stuck

By Vincent-Frédéric Mivelaz

The Bank of England has no choice today but to maintain its monetary policy rate, unchanged since August 2018. Following the vote of no confidence from last Tuesday and convincing talks with the EU relating to the Irish backstop, the BoE will not move. Inflation accelerated moderately in November, with annual and monthly CPIs given at 2.30% and 0.20% (prior: 2.40%, 0.10%). The scenario of a Brexit deal, with a little less than 100 days to go under current deadline term, does not provide the central bank enough room of manoeuvre, as cases of deal or no-deal would render totally effects on the British economy. The British pound, which largely recovered from yesterday’s dovish rate hike from the Fed, is expected to weaken further, as monetary policy remains paralyzed under such circumstances. The cable is currently given at 1.2682 (year-to-date: -6.06%), gaining 0.36% from yesterday’s Fed hike. Short-term, GBP/USD is expected to drop following BoE announcement, heading along 1.2605.

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Source: https://en.swissquote.com/
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