Stay on course, despite looming noise

While still benefitting from a global synchronised growth outlook (likely peaking), financial markets are getting nervous, experiencing the fatigue of a more mature phase with new sources of volatility arising. For the future, it will be key to anticipate how the exit of Central Banks (CB) from unconventional policies will unfold, while talks about protectionist policies start to intensity and we enter a phase of “slowing economic acceleration”, with growth above potential in most Developed Markets (DM), but decelerating in 2019.

President Trump has recently signed tariffs into law in an effort to boost the competitiveness of US producers, reduce the widening US trade deficit, and, ultimately, reinforce his nationalistic political support. At this stage, we do not expect to see a full-blown trade war, despite some recent escalation with China. However, this is emerging as a new source of volatility just when liquidity is diminishing and financial conditions are expected to tighten.

Consequences of protectionist threats could be far-reaching if the disputes spread further: the potential for retaliation and that more industries are targeted could undermine confidence and investment decisions. This could end up threatening the benign growth scenario in a kind of stagflationary environment, further adding to CBs’ conundrum: wait longer before going ahead with the removal of monetary stimulus (especially the ECB and the BoJ) or react more aggressively (the Fed) to supply side inflationary pressures, which could be exacerbated by the tight labour market conditions. The US February labour report highlights that the slack in the labour market is shrinking, and shows a particularly resilient goods producing sector in terms of payroll creation. Hence, the Fed would likely progress with rate hikes in an effort to cool down cyclical price pressures. On inflation, however, we don’t see a structural change yet, as the response of wages to a tighter labour market still appears to be very limited (flat Phillips curve). With this backdrop, our view is that investment opportunities will be in the relative value space, due to: the decoupling (different monetary policy stances) between the Fed, on the one hand, and the ECB and BoJ, on the other; different stages of the economic cycle for different countries; and sensitivity to external factors. Consequences of protectionist threats could be far-reaching if the disputes spread further: the potential for retaliation and that more industries are targeted could undermine confidence and investment decisions. This could end up threatening the benign growth scenario in a kind of stagflationary environment, further adding to CBs’ conundrum: wait longer before going ahead with the removal of monetary stimulus (especially the ECB and the BoJ) or react more aggressively (the Fed) to supply side inflationary pressures, which could be exacerbated by the tight labour market conditions. The US February labour report highlights that the slack in the labour market is shrinking, and shows a particularly resilient goods producing sector in terms of payroll creation. Hence, the Fed would likely progress with rate hikes in an effort to cool down cyclical price pressures. On inflation, however, we don’t see a structural change yet, as the response of wages to a tighter labour market still appears to be very limited (flat Phillips curve). With this backdrop, our view is that investment opportunities will be in the relative value space, due to: the decoupling (different monetary policy stances) between the Fed, on the one hand, and the ECB and BoJ, on the other; different stages of the economic cycle for different countries; and sensitivity to external factors.