Out of room
As contentious as the Tax Cut and Job Act of 2017 might have been, the effect was a return of animal spirits in the US economy which lasted nearly 18 months. Between Q1 of 2017 and Q4 2018, the Federal Reserve oversaw a rate hiking cycle which was heading towards a 3-3.5% target Fed Funds benchmark rate. Buoyed by expansion in US growth, other major economies were expected to bottom-out from their respective long-term downward growth trends and report a marked improvement in economic outlook. That never happened. In fact, as we neared the end of 2018, the effect of trade tensions on global growth conditions made it look as though the US would slow rather than becoming the saviour of global capitalism.
Since the beginning of 2019, the US rate path has been in a distinctly downward move, fuelled by increased tit-for-tat trade tariffs between the US and China which has paralysed the manufacturing sector. Business confidence levels have plumbed new lows as December’s US ISM manufacturing survey posted the worst reading since the financial crisis, despite a phase one US-China trade deal having been agreed. However, we may have seen a bottoming of growth conditions. Last week, both the Empire State & Philly Fed Manufacturing indexes climbed well away from recent readings and members of the Federal Reserve have indicated that they’re content with the current policy setting. This suggests that the outlook for the first half of 2020 might be improving; it will certainly need to as the Federal Reserve is close to the limit of monetary policy tools at its disposal.
By the third quarter of 2019, more than half of the world’s central banks had embarked on a path of monetary policy easing, following the Fed in a race to the bottom to support their own faltering economies. Many of these institutions have also recently echoed the Fed in signalling a pause to policy easing and there’s a sense that global growth has now begun a period of stabilisation. Just today, the IMF toned down their risk warning for 2020 growth and quantified global growth as 0.5% better than it would have been without the added central bank stimulus. Still, what remains if things get worse? Governments may find that the only solution will be to answer central bankers calls for an increase in fiscal policy.
Bottom Line: We’re not sure how long this pause will last but it’s clear that we’re approaching a pivotal point for the global economy. It’s now down to the data to see whether central banks have done enough to bring global growth back from the brink. A return to solid growth will need to stem from the US so the Fed will be keen not to tail off its recent asset purchase program too quickly, lest it pose another headwind to progress.
The trade-weighted Sterling index has traded in a tight range following the UK’s December general election, regularly crossing its 50-daily moving average. Last week, the index rebounded off the recent range’s low and drifted higher. This translated into a brief break above the 1.31 figure against the US Dollar and 1.1780 against the Euro. However, on Friday morning, a dismal UK retail sales reading anchored expectations of a Bank of England interest rate cut, sending Sterling lower again. Although the UK data calendar is light this week, the Purchasing Manager’s Index release will be important for the recent pricing in of a rate cut.
- UK labour market data will be released on Tuesday morning with average earnings expected to grow 3.1% year-on-year, down from 3.2% previously. The UK unemployment rate is expected to stay flat at 3.8%.
- On Friday, Purchasing Manager’s Index (PMI) data will be released. The Flash Manufacturing and Services data points are one of the most forward-looking indicators and will be key in outlining the economic outlook in the short-run, especially as markets are increasingly expecting an interest rate cut. Expectations are a contraction in Manufacturing at 48.8 and expansion in Services at 51.1.
Last week, the Euro index kept within its two-month range, briefly trading above the 100-daily moving average before falling to the bottom end on Friday afternoon. The index’s recent trading range has kept the currency between 1.10 and 1.1250 over the last two months. However, this week’s European Central Bank (ECB) policy meeting may bring some volatility for the pair on Thursday. Although a change in interest rates is not expected at all in 2020, the following ECB Press Conference with new lead Lagarde will be watched closely, as markets further unravel her stance as new ECB chief.
- Tuesday morning hosts the German ZEW economic sentiment survey. Expectations are a reading of 15.2 which signals optimism from investors and analysts (a reading above 0 signals optimism).
- On Friday morning, a series of European PMI data points will be released. French manufacturing and services are both expected to show expansion, along with German services. However, German manufacturing is expected to show contraction, albeit an improvement from last month. The Eurozone aggregate is also expected to show expansion in services and contraction in manufacturing.
Last week, the trade-weighted US Dollar closed in the green for the third week running and above its 50-daily moving average – a level that the Greenback had resisted for two months. The level may provide some support for the Dollar as further gains will soon test the 200 and 100 daily moving averages. Monday’s US public holiday means low liquidity could create short-term volatility for the Dollar. What’s more, commentary from this week’s World Economic Forum (WEF) annual meeting – which is attended by central bankers, finance ministers and business leaders from around the world – may create some volatility across asset classes during a light week of US data releases.
- Friday afternoon hosts Flash Manufacturing and Services PMIs for January, and expectations are both expansionary at 52.6 and 52.5 respectively. The US manufacturing recovery will be closely watched, as the actual reading has met or beaten expectations every month since September 2019.