As we look out to 2019, we believe there are three key themes that will persist into the new year.
Theme #1:
Divergence
While we expect economic growth to remain solid, there has been greater divergence in the past year in terms of growth. We believe such growth divergence is likely to continue, yet it will probably be constrained by the strength of US consumption and investment (as well as the strength of Chinese stimulus), which is likely to help boost growth in the rest of the
world to at least some degree. We also expect some divergence in inflation in the coming year, with some economies experiencing upward pressure on wages as well as rising input costs.
Theme #2:
Disruption Monetary policy disruption
The US Federal Reserve (Fed) is very likely to continue on its path of regular gradual rate hikes. It would probably take a major downturn in economic data or a very severe US stock market correction to divert the Fed from that rate hike path at this juncture. In addition, the Fed is also conducting balance sheet normalization – a powerful tool in and of itself -- at the same time as it is raising rates. The pre-set course calls for larger amounts of assets to be rolled off the Fed’s balance sheet each quarter. which means a significant possibility of market disruption (we have already seen US monetary policy disrupt emerging markets in 2018). In addition, the European Central Bank
(ECB) is due to begin winding down its own quantitative easing program from the end of 2018, which could contribute to further disruption in Eurozone bond markets, which are already experiencing renewed divergence. Plus there is the risk that, in October 2019, a more hawkish president could replace Mario Draghi as ECB President, which may in turn cause greater volatility for Eurozone stocks and bonds. In addition, more emerging markets economies are tightening -- many doing so to keep up with the Fed – creating an overall environment that is less accommodative.
Geopolitical disruption
We have seen significant geopolitical disruptions in recent months, which threaten structural fragmentation in the global economy and are already contributing to divergence in global growth as well as creating significant volatility in financial markets. For example, the rejection of Angela Merkel’s leadership in various German regions), the difficulty the UK has had in orchestrating its Brexit from the European Union and Italy’s tensions with the EU over its desire to increase government spending in violation of Eurozone rules are contributing to volatility and pressure in European markets including the euro, government bonds and equities – especially bank stocks, and are likely to drag down growth in the UK, Italy and to some extent Europe as a whole. The US withdrawal from the Iran nuclear accord had contributed to a surge in oil prices because the hard line requiring sanctions compliance by many countries pointed to much tighter global oil supply, but the granting of many sanctions waivers has now lowered this risk contributing to a sharp oil price correction – all of which has affected currencies and markets in many oil exporting and importing countries. Of course, the greatest geopolitical risk is the potential for full-blown trade wars, which seems more likely than not at this juncture. This can place downward pressure on economic growth in a variety of ways: It increases economic policy uncertainty, which typically reduces business investment; it increases input costs, which reduces profit margins or is passed onto consumers, who in turn typically reduce their spending in other areas; or it results in demand destruction. Finally, it can disrupt supply chains and make economies less efficient and productive. There is hope for renewed negotiations, perhaps starting with a truce at the late-November G20 Summit, when Chinese President Xi and US President Trump are expected to meet. But we would caution that any relief rally could be temporary, because US concerns span many areas beyond trade, including intellectual property protection and national security.