Market Insights – 3 décembre 2018

Weekly financial & economic analysis.

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The sharp Q3 slowdown in the Swiss economy caught investors off guard. GDP shrank by 0.2% quarter on quarter, its sharpest drop-off in over two years. While we think this slowdown will be short-lived, the SNB is likely to proceed with greater caution when it comes to monetary policy.

In France, the ‘gilets jaunes’ protest movement is now about more than just rising fuel prices. In addition to temporarily weighing on growth, the movement could hinder upcoming reforms, like the one to the country’s pension system. 

Oil producers have started to adjust output in response to the sharp decline in oil prices, which have fallen by more than 30% from the highs recorded early in the quarter. Canada has ramped down output, and Opec is expected to agree to a production cut at its meeting on 6 December. It is hoped that these moves will stabilise prices.

Neutrality is all relative

Jerome Powell has been Fed chair for several months now, and his management style is now coming through. At the risk of denting his not-yet-fully-established credibility, he has changed his tone radically recently – a sign that he can be pragmatic and adapt to a fast-changing environment. In the late summer, he explained that the fed funds rate was a long way from neutral (i.e. the level at which interest rates are neither propping up nor holding back the economy). The underlying message was that investors could expect many further rate hikes. Last week, however, he said that the fed funds rate was “just below” neutral.

It is rare for the chair of a central bank to do an about turn in this way. But investors aren’t holding it against him, quite the opposite in fact. The climate has changed considerably since his initial statement, and not only when it comes to the stock market. Economic indicators are pointing to a slowdown in the USA, and global economic activity is also losing steam.

Mr Powell’s recent caution can also be explained by another major development that the Fed had not foreseen: oil prices have plunged more than 30%, and this will have a considerable impact on inflation in the coming months. The Personal Consumption Expenditures (PCE) deflator – a key indicator – could drop below the Fed’s 2% target as a result. Until now, the Fed had been banking on using the uptick in wages to justify its monetary tightening. But the digitalisation of the economy and the resulting structural changes appear to have limited the impact that rising wages have on retail prices. At the same time, a decline in oil prices is sure to quickly affect inflation, especially in the USA, where fuel taxes are low.

While a fourth 2018 rate hike at the Fed’s 19 December meeting seems like a given, only two further hikes are now forecast for 2019. Whether they actually take place will depend largely on what happens to the economy and inflation.

Powell’s change in tone helped to lift spirits on the stock markets. From a technical standpoint, Wall Street has been given a boost. After retesting its October lows, the S&P 500 is likely to rally at the end of the year, especially now that trade tensions have eased.

Trump-Xi trade tensions – one step at a time

At their meeting at the G20 summit, presidents Trump and Xi took steps to ease trade tensions and agreed not to impose new import tariffs before 1 March 2019. They had previously intended to raise tariffs on 1 January. In the short term, this development allows some time for the stimulus measures brought in by China in recent months to have an impact. But China has had to ‘buy’ this time with a series of concessions: it agreed to reduce or remove tariffs on cars imported from the USA and to purchase agricultural, energy and industrial products from the Americans to reduce the trade imbalance between the two countries.   

But we think that the two countries are a long way from reconciling their differences. The agreement is merely a truce on further tariffs and makes no mention of the ones already in place. And, as from the outset, the decision to resolve the dispute is in the hands of a rather capricious US president. What’s more, the uncertainty generated by the tariffs – and the repercussions on investment decisions – have more of an impact on the economy than the tariffs themselves. Even if the tensions eased at the weekend, that uncertainty remains.

Prior to the meeting, expectations were so low that the outcome can only be encouraging. It may only be a stopgap solution but it is still a step in the right direction and could lift the bearish sentiment that has weighed on stock markets – and especially emerging markets – in recent months.

To go deeper

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