Policy decisions made some 11,000 kilometres apart will drive the trajectory of the 2019 global business cycle. It rests on the ability of the US Federal Reserve (Fed) to successfully normalise monetary policy and engineer a soft landing for the economy, and on China’s skilful calibration of its economic policies to stimulate a rapidly slowing economy without fuelling a credit bubble.
THE FED’S DILEMMA: PAUSE OR PRESS ON
In 2019, the Fed will be looking at an economy that is gradually losing momentum, in part due to its own tightening actions and to typical late-cycle labour supply constraints. However, as long as wage growth remains moderate and inflation trends close to the 2% target, any rate increase beyond the neutral rate will likely seriously weigh on US growth.
PineBridge expects the Fed will pause or even more permanently suspend the current rate hike cycle by mid-2019. If the Fed stops at neutral, the US economy will land softly in 2020, with GDP growth at close to 2%, allowing the US business cycle to extend beyond our forecast horizon.
CHINA’S BALANCING ACT: MAX IMPACT, MINIMAL PAIN
Official Chinese GDP growth figures held up fairly well in the third quarter of 2018 at 6.5%. However, anecdotal evidence points to a more serious slowdown in economic activity.
The biggest headache for China is more confrontational US trade policy. With the dispute unlikely to end anytime soon, Chinese authorities are focusing on re-stimulating the economy using a combination of monetary and fiscal measures – easing credit and increasing money supply, and cutting taxes, among others. Since March 2018, the yuan has also fallen over 10% against the US dollar, offsetting a significant portion of the adverse effects of the tariff increase on the affected sectors and increasing the profit margin of indirectly affected companies.
The problem is China’s tools come with potentially serious side effects. Currency depreciation could increase savings outflows. Accelerating the supply of credit to the private sector will add to already high levels of debt.
PineBridge believes China will be able to offset most of the trade headwinds, and real GDP growth in 2019 should only be marginally weaker than previously anticipated. If China can prevent a more abrupt slowdown in 2019, the global business cycle can extend beyond our forecast horizon.
POLITICAL EVENTS ADD TO VOLATILITY
Politics too poses risks in other parts of the world in 2019. Parliamentary elections in the European Union could further destabilise its core constituency if ruling coalitions in France and Germany suffer significant electoral losses. Elections in India, Indonesia and Argentina have the potential to create more market volatility. In Japan, plans to raise consumption taxes could also slow growth.
HOW AND WHERE TO INVEST
Turning points in global business cycles always generate substantial volatility, but imminent recession is not inevitable. Instead, we expect the key macro theme will be re-convergence – US growth slows down in the next two years and catches up with the rest of the world.
In equities, we expect to see opportunities in emerging markets, notably in China A-shares, Asia ex Japan more broadly, India, and Latin America.
We also see good growth potential in revenues and in the margins of companies that are producers and users of smart capex, both in the technology and industrials sectors, and, more broadly, where we see companies benefiting from higher investment spending. These are company-specific, idiosyncratic alpha opportunities to be found globally.
In fixed income, while we believe markets will remain largely favorable in 2019, negative forces can emerge quickly and unexpectedly. A modest dialing back of risk in each segment makes sense in the current environment, reducing high beta exposures and incrementally lowering duration risk profiles, particularly in developed markets outside the US, as well as focusing on higher quality credits within segments.
The road toward an extension of the global business cycle could take some twists and turns, where winners and losers are widely dispersed. As such, PineBridge believes investors need to be active and selective to get the most out of their portfolios.
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Last updated 6 March 2017.