With the FOMC minutes out later today and another round of trade talks just beginning, greater clarity in these two dynamic policy realms continues to be a key driver of markets, particularly as both US and Chinese economies face growth headwinds. Markets will be closely parsing Fed policymakers’ outlook, but already expect rates to remain unchanged through 2019 with implied probabilities at 72% with a 22.4% expectation of a quarter percentage point rate cut by the end of January 2020. Following the Fed’s about-turn to “be patient” both stocks and bonds have rallied this year on the more accommodative stance: with high-quality corporate bond indexes marking their “best start to the year since 1995” according to the FT.
Alongside clarity on the discussion behind how the Fed moved from “some further gradual increases” to being “patient” readers of the minutes will be looking for any hints on whether the Fed plans to fully unwind its balance sheet this year (as a couple of Fed Presidents favour), although a clearer plan on this isn’t expected until March. Given that the term-spread between 1- and 10-year Treasuries has already been hovering around 9 basis points recently, and throughout 2019, it would not take much to reach a truly inverted yield-curve (beyond the existing 1-5 year inversion). Such an inversion is a well-recorded indicator of a recession – but alone is somewhat of a weak signal and only indicates potential negative growth within the next 12 to 24 months. Nevertheless, plenty has already been written warning about the global impact of growth headwinds across the superpowers: given the importance of the US and Chinese markets, they are widely expected to lead the global business cycle.
But recently concerns have arisen that the Eurozone is unwittingly challenging the US to lead the global business cycle into recession. With Italy in recession and the German powerhouse only narrowly avoiding one, with 0% Q4 growth following a negative Q3, real growth in the Eurozone has fallen to its lowest since the sovereign debt crisis. A recession in Europe seems to be a more imminent risk to global growth than the more gradually building concerns over the US economy, and the trade impasse over agriculture in the US-EU trade talks seem just as insurmountable as the intellectual property disagreements between US and China. As Peter Chase from the German Marshall Fund Think Tank observes, “Both sides put their cards on the table but they seem to be playing different games”. If the US does ever impose 25% tariffs on the European auto industry that could well be the final straw for growth across industrial Europe and beyond; even if Trump is sensible enough to avoid such brinkmanship growth in Europe continues to remain more vulnerable at a number of levels.