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The developed world’s central banks have firmed up their commitment to lower interest rates, and risk markets have continued their ascent. However, the trade dispute continues to weigh on global activity (Guide to the Markets – UK p5).
Our new focus chart puts the recent tariff increases into historical context (p21). At this stage, the tariffs themselves are unlikely to threaten the expansion. The second-round effects – by dampening corporate sentiment – are likely to be greater.
Companies have scaled back investment (p14). If this, in time, leads to job cuts then the resilience we have seen in consumer spending and service sector activity could falter. This risk will grow if the trade war escalates further.
The hunt for yield has also boosted stock prices. The key question is whether the macro backdrop can support positive corporate earnings growth through to next year.
Analysts have scaled back their estimates for earnings growth this year markedly (p49), but earnings are expected to recover to a robust pace in 2020.
In our view, such a recovery in earnings will not materialise if trade tensions escalate. Moreover, the global malaise will weigh on the US economy and markets. We’re also concerned that higher wages will eat into corporate margins in certain sectors (p73).
The fixed income markets have responded warmly to the news that central banks are looking at ways of easing policy, either by rate cuts or further asset purchases (p84). The Federal Reserve has indicated a willingness to cut rates in the near future. The European Central Bank’s toolkit looks decidedly bare, but it too has shown a willingness to lower rates into deeper negative territory in its bid to push up inflation.
The Bank of England is the only central bank still indicating any inclination to hike rates, although Brexit uncertainty clouds the outlook significantly. Roughly half of the developed world government bond market now has a yield below 1% and almost a third has a negative yield (p83). Investors are once again forced to hunt for income, which has helped credit spreads tighten.
Although it does not appear to be in President Trump’s interest to risk a slowdown ahead of his re-election campaign, the roots of the trade war run deep, and there appears to be considerable appetite among the US electorate to continue pursuing the “America First” agenda. The key risk is that the uncertainty generated by the dispute causes firms not only to scale back investment but also to cut jobs.
In the UK, Brexit uncertainty looks set to persist. We doubt a new prime minister will do much to change the outlook given the UK population remains heavily polarised between the desire to walk away without a deal and the desire to vote again and remain (p37). Sterling assets may not shed what we perceive to be a considerable Brexit risk premium for some time.