A first look at 2019

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12/07/2018 | 04:42 pm
It’s that time of the year when we start thinking about the next one. Will there be a recession? How will the markets behave? What will the Fed do? Let’s have a look at what analysts have to say:

There are so many mixed signals that it is difficult to know what to expect in 2019. Part of the U.S. Treasury yield curve “inverted” this week, with shorter-dated securities yielding more than longer maturities. The bad news is that when this happened in the past, it was generally followed shortly afterward by an economic recession. But on the other hand, many economic indicators are in the green and the IMF just said it does not see any risk of recession in the United States and that growth forecast for 2019 remained "rather strong".

To add to confusion, there’s Jerome Powell and the Fed. Back in October, the Fed boss had investors worried when he said that the Fed was "still very far" from the "neutral" rate to which it aspires. Otherwise known as the Goldilocks state, it is neither too hot or too cold, promoting growth without feeding price increases. But on November 28, he completely reversed its tune. Rates are now "just below" a neutral level, all of a sudden. By saying so, he signaled to markets that there will be less rate hikes next year than the 5 many anticipated.

So what to expect?  After all, the US economy’s growth is on pace to exceed 3%, the unemployment rate is at a 48-year low, and inflation is right on target. But as we approach 2019, the question is how long will the good times last.

According to Goldman Sachs, not so long. In a new report, it estimates that growth is likely to slow significantly next year, “with tighter financial conditions and a fading fiscal stimulus to be the key drivers of the deceleration.” It notes that firmer wage pressures coupled with additional tariff rounds should boost core PCE inflation by the end of 2019.

Analysts at Jefferies agree that the economy will slow next year, and believe that a gradual Fed tightening is good medicine for the economy, and could bolster the stock market and lend confidence to the continuation of the benign economic environment characterized by low unemployment, decent GDP growth, and low inflation.

A real paradox

Meanwhile, Nordea Asset Management notes that the Fed’s more restrictive more restrictive monetary policy could weigh on global growth and markets in the first half of the year, before giving way to a recovery in the second half thanks to a less aggressive monetary policy. It expects the global slowdown to continue in the coming months. “In this context, the October correction recalls that the path of risky assets is increasingly dependent on monetary conditions and that equity markets are approaching their peak. Risky assets are therefore expected to remain under pressure in the first half of 2019, while the second half of the year may offer some relief to investors. Indeed, the headwinds in the US economy are expected to ease as external risks increase, pushing the Fed to pause its monetary tightening.”

Barclays highlights a paradox: while 2018 has turned into a nightmare for global financial assets, not one major economy is near recession. There has been no financial meltdown, no large sovereign or corporate has defaulted, and earnings growth has been decent. It tries to explain this in a report: “Bond returns have been dragged down by the Fed hiking cycle – no surprises there. Equity investors have looked past strong 2018 earnings to single-digit earnings growth in 2019. Emerging market assets have been hit by country-specific issues, a slowing China, and USD strength. Political risk seems skewed to the downside, in the US and Europe. And in some cases, we feel markets have just over-reacted”.

It also expects global growth to be weaker in 2019 than in 2018, although slightly, due to a surprisingly weak eurozone growth. But it sees some hope next year: “2019 returns are unlikely to be as bad as 2018. At some point next year, the Fed will likely approach the end of its hiking cycle. We expect the world’s major economies still to grow at or above trend. And risk assets are more reasonably priced after the year-long pullback”.

Italy will weigh on the global economy

Europe is expected to drag global growth down, according to most analysts. In a new report, Goldman Sachs says that the impulse from past tailwinds to growth faded this year and the acceleration in Euro area activity is behind us. “We expect the partial rotation from external to domestic demand to continue for the Euro area as a whole, but to falter in Italy. There, we expect financial pressures – including through wider sovereign spreads – to prevent the government’s planned fiscal easing from supporting GDP growth.” Italy is therefore the source of its downwardly revised 2019 outlook for the euro area, with growth forecast lowered by 0.2pp to 1.6% in 2019.

Meanwhile, Barclays has revised its global growth forecasts further down from the September Global Outlook, to 3.9% and 3.7% in 2018 and 2019, respectively, with US growth forecast of 2.9% for both years. The euro area growth now predicted to reach only 1.9% in 2018 and 1.5% in 2019 and China to grow at 6.6% and 6.2%, respectively.

Romain Fournier
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