Chart of the week – Heaven in the havens?

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Market volatility has been seesawing so far in August as various events have fuelled talk of global recession. While we do not share this analysis, we believe it is imperative to understand how this assessment arose.

  • Angst about an recession is roiling markets. Unresolved issues range from flagging growth to political jack-in-the-boxes
  • Will central banks prolong the easing cycle?
  • Consider tactical investing

Poor data and worsening political risk

From a macroeconomic perspective, several major economies in Europe have disappointed, including Germany and the UK, which both posted a contraction in second-quarter GDP.

Data from China, the world’s second-largest economy, pointing to slowing industrial production and retail sales has added fuel to the concerns.

Given the risks to international trade, reassuring data from the US on domestic demand, namely a rebound in retail sales and a still-solid labour market, have failed to comfort markets rattled by the possibility of a currency war initially involving the renminbi and the US dollar.

Adding to the angst is a flare-up in perceived political risk: the domestic debate on Brexit is back in full swing with no resolution in sight, while in Italy, a falling-out among the coalition partners has sunk the government with a general election looking likely.

At the same time, the US and Europe do not see eye to eye on Iran and neither do the US and China on trade.

Argentina was plunged back into crisis this month after centre-right reformist president Mauricio Macri suffered an unexpectedly heavy defeat in the first round of elections, raising chances of a return to power of the populist Peronists in October.

Generally, the perspective of  protectionist policies is clouding the prospects for the global economy, putting pressure on central banks to step into the breach with (renewed) pro-growth and pro-inflation policies.

Taking a global view, the IMF has labelled global growth subdued, citing Sino-US import tariff rounds, threats to tech supply chains from possible US sanctions, Brexit-related uncertainty and the unsettling impact of rising geopolitical tensions over energy prices. Its world economic outlook has gone from “broad-based growth” with “notable upside surprises” to “sluggish”. Safe havens, anyone?

Exhibit 1: Commodities tied to the economic cycle such as crude oil and copper have given up ground as the slowdown looms; safe havens such as the US dollar and gold have benefited (2019 to 20 August)

 Commodities tied to the economic cycle such as crude oil and copper have given up ground as the slowdown looms; havens such as the US dollar and gold have benefited markets

Source: Bloomberg, BNPP AM; August 2019

Unsettling uncertainty

Rather than focusing on clearly identified risks to world trade, we believe the talk should be of growing uncertainty. The US announced additional tariffs on Chinese products spared that fate so far, only to delay some of them so as not to penalise US consumers. The Sino-US dialogue on a trade deal appears to move in regular spurts, leaving equities to react this way or that as the news, often imprecise, changes.

While chatter about a possible ‘currency war’ increased  after the RMB/USD exchange rate broke through the psychologically significant level of 7 renminbi to the dollar, little action followed the US Treasury designating China a ‘currency manipulator,’ causing the war of words between Washington and Beijing to subside (but not go away).

President Trump has instead reverted to criticising the Federal Reserve, saying its ‘high interest rates keeps the dollar high.’ The president subsequently accused the Fed chairman of a ‘horrendous lack of vision.’

Flight to safety floors bond yields

Such sniping further unnerves already jittery investors who have been opting to ditch risky assets and pile into traditional safe havens including the US dollar and the Japanese yen, gold and government bonds.

The resulting inversion of sovereign debt yield curves is flashing up another warning light, on top of the alarm bells set off by politicians’ populist and protectionist moves and their attempts at intervening in central bank policy. The upside-down curves are traditionally a sign of impending recession.

Where does all that leave the central banks? In the emerging markets, at least seven central banks have cut their key rates since July. New Zealand and Australia have joined in. More of a bellwether, the Fed has cut its key rate, but the rhetoric that accompanied this decision was not seen as sufficiently dovish by markets to lift spirits and hopes for the outlook.

All eyes are now on an expected – appropriate – loosening of monetary policy by the ECB in September. Before that, markets will scrutinise the 22-24 August Jackson Hole symposium for any guidance on the ‘challenges for monetary policy’ which is the theme of this year’s meeting of central bankers and other policymakers in the US state of Wyoming.

And what about investing?

Where does all this leave investors? Quaking in their boots? Hugging the sidelines? Hoping for central banks to come to the rescue even though their room to manoeuvre on interest rates is limited and stimulus through quantitative easing (QE) would push bond yields even lower?

Given the long list of unresolved issues highlighted above, a sense of unpredictability as well-trodden paths (in politics and international relations) are abandoned, and concerns that there is no end in sight to upheaval and instability, uncertainty appears to be the new constant for markets and investors.

Opportunism and pragmatism might have to take over in investors’ search for yield. This would make tactical exposure the predominant approach in earning short-term returns, much as tactics now seem to be the way to go in managing many economies. For more strategic positions, equally strong convictions and nerves would appear to be the current prerequisites. Will fortune favour the brave?

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Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.

Nathalie Benatia

Macroeconomic Content Manager

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