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In this edition, our analysts provide views on the US-China trade war, upcoming EMEA elections, and the strengthening US dollar.
The Lens: March 28, 2019
Big economies pivot to stimulus
- Weak economic data in China and the EU has led to a major change in the global policy trajectory. In March, the largest economies in the world all took steps to support economic activity.
- China has been trying to offset a larger-than-expected internal slowdown with limited policy measures since mid-2018. The administration announced stronger policy measures, including tax cuts, in March.
- Partly driven by weak China demand, the EU outlook weakened. The European Central Bank (ECB) implemented supportive policy measures.
- US Federal Reserve officials communicated that they no longer planned to hike rates in 2019.
Our view
Economic policymakers are taking steps to support domestic growth in order to arrest a slowdown that started in China, spread to Western Europe, and threatens to end the global growth cycle. People expected the stimulus implemented by China and the ECB. However, there were concerns that these measures would be insufficient to offset the magnitude of the slowdown. The lower Fed rate outlook is a big positive surprise. The policy support is now global, and this improves the chances that it will succeed.
Business implications
Supportive policy measures in major markets will support global demand. This will not just support large economies, but will spill over and help stabilize demand in smaller economies. There are two main drivers. First, higher external demand will support export-dependent economies. Second, easier global financial conditions mean that smaller economies will no longer be forced to keep hiking domestic interest rates just to match the pace of the Federal Reserve, which can support domestic activity. We have seen smaller central banks that were hiking rates back off of planned rate hikes or implement rate cuts. These include India, Indonesia, and Nigeria.
Ryan Connelly, Senior Analyst for Global Economics and Scenarios
US yield curve inverts, but US recession not expected in 2019
- Last Wednesday, the Federal Reserve signaled that it no longer planned to hike interest rates in 2019. Markets responded by buying up 10-year US Treasury bonds. The yields on 10-year US Treasury securities fell below the yields on 3-month Treasuries.
- This is the first time the yield curve inverted since the financial crisis.
- Yield curve inversions are, historically, a reliable leading indicator of US recession. The yield curve inverted prior to all nine US recessions since the 1950s.
- Even if we believe this market signal is accurate (and there is some reason to believe that it is not currently), there are long lags between the yield curve inversions and the onset of a recession: as long as 24 months, with an average of 13 months.
Our view
Paradoxically, because this yield curve inversion was triggered by a more supportive Federal Reserve, the risk of a 2019 US recession is even lower than it was previously. There was concern that the Federal Reserve might make a policy mistake and trigger a recession by hiking too fast. However, now the Federal Reserve is backing off. Market fundamentals in the US remain strong, with strong job market gains, rising wages, relatively weak levels of core inflation, and a supportive Federal Reserve. At some point in the future, the US will enter a recession, but it will not be in 2019.
Business implications
The US continues to be the safest market for sales targets in 2019. Rising nominal wages coupled with weak core inflation creates a perfect market for firms to pursue premiumization strategies.
Ryan Connelly, Senior Analyst for Global Economics and Scenarios
FrontierView clients: See our Events to Watch for 2019 for our US recession scenarios
Despite weaker US rates, the US dollar broadly strengthened
- Since the Federal Reserve lowered interest rate guidance for 2019, the US dollar strengthened against most currencies.
- This runs contrary to normal expectations of US dollar performance. Higher US interest rates are normally expected to increase demand for US dollar assets. However, weaker US interest rates are expected to decrease demand for US dollar assets.
- Markets seem to be taking lower US interest rates as a signal that global growth is slowing, and are pulling back from risk assets. The worst-hit currencies are highly liquid currencies that tend to perform poorly when global manufacturing growth slows (see chart below).
- This seems confirmed by the poor performance of US equities, which instead of strengthening on the back of a more dovish Fed, have sold off slightly since the Fed announcement.
Our view
The global slowdown has been evident for many months. First it was in the soft data, then in survey data, then in hard data. FrontierView made major downward revisions to its global forecasts for 2019 back in January. Though the US economy continues to look strong, the Federal Reserve eased policy due largely to concerns about the external environment–which will support global growth. But instead of focusing on the accommodative Fed as a positive, markets are focusing on the negative–that the global environment was weak enough to merit such a major shift in the Fed policy trajectory.
Business implications
The shift in the Federal Reserve policy stance is significant, and will lead to substantial changes in local interest rates and exchange rate expectations for 2019. But this will not lead to universally stronger, or weaker, exchange rates against the US dollar. Local factors, most notably the response of domestic central banks to the softening of global financial conditions, will lead to variation on a country-by-country basis.
Ryan Connelly, Senior Analyst for Global Economics and Scenarios
Upcoming EMEA elections are rife with potential surprises
- A number of EMEA markets are facing elections in the coming three months that could shake up domestic political establishments and prompt policy change.
- Events include Turkish local elections and Ukrainian presidential elections on March 31, Israeli general elections on April 9th, Spanish general elections on April 28, South African general elections on May 8, and European parliamentary elections on May 23-26.
- In addition, Algeria is supposed to hold elections on April 28, but after popular protesters forced incumbent President Abdelaziz Bouteflika to announce he will not run for another term, the country is going through an uncertain power transition that has resulted in the indefinite postponement of elections.
Our view
Policy change is particularly likely in Ukraine, where we expect a comedian to win the elections; and is very likely in Algeria, given changes to the ruling regime there. The Israeli election remains close, but could have significant implications for stability in the region. In Turkey, a weaker-than-expected performance by the incumbent party will strengthen the case for reform, while a stronger majority in the incumbent party in South Africa will embolden the president to pursue more aggressive reforms. The European parliamentary elections will likely result in fragmentation with more prominent populist parties present, but this is unlikely to drastically shift policies in the region. Despite high media attention, significant policy changes are unlikely following the Spanish election, where we expect the Socialist party to win, but without a full majority.
Business implications
Election uncertainty in key markets could cause customers and partners to postpone investments and be particularly price-sensitive. Executives should also watch out for sudden currency movements in countries where unexpected results spook investor sentiment, particularly in the context of broader concerns over the global growth outlook and ongoing disruptions such as Brexit. Companies should be ready to adjust to and–where possible–partner with governments in shaping policy shifts going forward.
Martina Bozadzhieva, Managing Director, Head of Research
FrontierView clients: See our EMEA Regional Outlook for 2019, updated in March
US-China trade war update: So much for a March summit
- President Donald Trump built up expectations that the US-China trade war would be resolved at a summit with President Xi Jinping in March. But progress in the trade talks has stalled, and there are no current plans to hold a summit.
- The US wants China to make verifiable commitments that will address IP theft and structural issues that put US multinationals at a competitive disadvantage to Chinese firms within China.
- Some US demands are incompatible with the Chinese economic model, and Chinese officials have pushed back against these demands. But Chinese officials also want to find a way to end the trade war to find tariff relief.
- Trump said on March 20 that he wanted to keep tariffs on China until he is sure China is complying with the trade deal, but this could take years.
Our view
Do not expect a quick resolution to the US-China trade war. There is bipartisan support in the US to continue to put pressure on China to change its economic practices. Xi cannot risk losing face by capitulating to US demands. US demands on China would require fundamental changes to Chinese domestic economic policymaking that would reduce the power of the state to direct economic activity, which Chinese officials won’t accept.
Business implications
The US-China trade war revealed that firms relied too much on integrated US-China supply chains. Going forward, building geographic diversity into supply chains is a management priority. The best way to avoid disruptions is to localize production as close to demand centers as possible. This reduces geopolitical risks, but also regulatory and currency risks, and these more complex supply chains are now possible due to advances in logistics technology.
Ryan Connelly, Senior Analyst for Global Economics and Scenarios
FrontierView clients: See the Singapore Executive Breakfast Presentation for the most recent updates to our US-China trade war scenarios