Macroeconomic Outlook: Q4 2019

Macroeconomic Outlook: Q4 2019

FIXED INCOME:
Global growth is slowing due to weakness in Europe as well as tariffs hindering trade between the U.S. and China. Growth in the U.S. of 1.5-2% should provide a positive backdrop for fixed income investors, enabling domestic corporate credits to maintain their financial profile.

The Fed is turning back toward data dependency as the economy slows while employment continues to grow, and near-term inflationary expectations remain below the Fed’s 2% target. We expect one more cut in the Fed Funds target rate in late October, and depending on the data, possibly one more in December. In large part, a positive outcome in the trade discussions would be required to avoid this second cut in the quarter. The treasury yield curve, which had inverted briefly, is back to being positive.

The U.S. and global economies are slowing, leaving central banks little choice but to lean toward easing monetary policy. The ECB has gone so far as to reinstate their bond buying program, which should benefit the U.S. fixed income markets. Having said that, talk of the Fed easing only one more time this year may push the U.S. dollar higher, potentially increasing hedging costs for foreign investors. Doing this would lessen demand for foreign investors looking to purchase U.S. dollar debt.

 

Inflationary expectations continue to struggle to meet the Fed’s 2% target. This below target story has been playing for many years and gives the Fed room to cut rates as they see fit. Meanwhile, energy prices remain low, helping fuel consumers’ appetites to spend. Tame inflation benefits fixed income assets.

Consumers are benefiting from low unemployment, positive wage growth, low inflation, and low interest rates. Consumer confidence has inched downward a touch, but remains high.

 

The unemployment rate in the U.S. labor market is near historic lows. This environment, coupled with average hourly earnings growth, is a positive for consumer spending, which represents over 2/3rds of the nation’s GDP. Markets continue to monitor wage growth for possible signs of wage inflation; however, most areas point to little-to-no increase. Labor shortages continue to hinder the economy.

The on-again/off-again trade talks with China and Europe are creating plenty of volatility and uncertainty for the markets. The markets have realized that an agreement with China may not get done until after next year’s election, and are erring on the side of caution (i.e. lower government yields and wider credit spreads). Meanwhile, the USMCA continues to wait for Congressional approval.

 

Lack of clarity over trade talk outcomes and tariff discussions have resulted in business decision-makers turning cautious, which is being reflected in lower capital expenditures. Should this caution expand, the economy will slow further. While such a slower growth environment is a positive for risk-free rates, the same cannot be said for corporate financial conditions.

 

The slowdown in global growth is fueling the move to lower sovereign rates. Thus far, the dollar has benefited, which is a negative for foreign investor demand, hence credit spreads in U.S. corporates.

Trade and tariff discussion with China, nuclear concerns with North Korea, Saudi Arabia, and Iran represent the geopolitical hot spots. However, uncertainty over the pending Brexit (which will end eventually), and their relationship with Europe has also contributed to growth slow-down in that region.

 

EQUITY:
Economic data in the U.S. is presenting a mixed picture. Manufacturing data is in contractionary territory and industrial production has deteriorated. Inventory rebuild should be a positive contributor in the fourth quarter. Trade concerns will continue to weigh on capital investment decisions. Services data has weakened but is still indicating expansion. The consumer remains the engine of growth. Housing data has strengthened as mortgage rates have declined. Earnings growth is expected to slow but remain positive. U.S. economic growth will slow to a moderate pace of 1.5-2.0%.

Data indicates that the job market remains strong and economic activity has been rising at a moderate pace. Business fixed investment and exports have weakened in the face of headwinds from slowing global growth and trade policy. The Fed will act as appropriate to sustain the expansion, which should lead to at least one additional rate cut in 2019. A deterioration in the growth environment would result in further easing. Stimulative monetary policy should be viewed favorably by financial markets.

 

Central banks around the globe have been easing monetary policy in an effort to stimulate growth, which has weakened as trade tensions between the U.S. and China have weighed on the global industrial economy. In the third quarter, 16 central banks lowered interest rates.

Reported inflation statistics suggest a continued mild environment. Core inflation is low across the globe, and commodity prices remain subdued. In the U.S., there has been some slight upward pressure in medical care and clothing prices. E-commerce trends and a heightened competitive environment are limiting the opportunity to raise prices. Rising tariffs have the potential to push end-market prices higher. Wage pressure is moderate. Housing prices gains are slowing, improving affordability.

Consumer confidence data remains elevated but has moderated from highs. A stable employment market, improving net worth, and subdued inflation have boosted sentiment and supported gains in retail spending. Spending is trending toward a healthier, experiential, and less wasteful lifestyle. Lower mortgage rates and slowing price gains have raised housing affordability.

 

The U.S. labor market is strong and the jobs outlook remains robust. The jobs hard-to-get survey hit a 19-month low in the September Conference Board Consumer Confidence survey. Initial jobless claims show no signs of deterioration, and layoff announcements remain in record low territory. Business leaders continue to cite difficulties in hiring and retaining skilled labor.

 

Trade negotiations are set to resume in the fourth quarter, but there remains a lot of ground to cover before a comprehensive deal can be reached. In addition to already existing tariffs on $250 billion of imported Chinese goods, an additional $300 billion of goods have been identified to be subject to a 25% duty at some point in the future depending upon negotiations. China has also threatened further escalation of duties on more than $100 billion of U.S. goods. The uncertain timing and progress has stymied capital investment and raised the level of volatility in financial markets. Auto tariff issues also remain outstanding with European trading partners. The revised North American trade deal between the U.S., Canada and Mexico has yet to be ratified and could raise trade headwinds until the deal is completed. Higher tariffs will slow global growth and impact corporate profitability.

Optimism about the global growth outlook has been diminished as the trade war between the U.S. and China remains unresolved. The Business Roundtable CEO Economic Outlook deteriorated in the third quarter and suggests moderation in the pace of economic growth going forward. More than half of U.S. CFOs believe the U.S. will be in recession by the third quarter of 2020. Economic and trade uncertainty has had a negative effect on capital expenditure plans. Difficulty hiring and retaining qualified employees remains a top concern. Profit margins have been impacted by already enacted tariffs, and the potential for further deterioration is elevated should tariffs be raised.

 

Global growth is stagnating. China and Europe continue to exhibit signs of weakening. Chinese trade data has deteriorated. The Eurozone PMI dropped to the lowest level in seven years. Germany appears headed toward recession. The UK reached its lowest level since 2013, while the Chinese PMI has also fallen into contractionary territory. The introduction of monetary and fiscal stimulus is increasing in an effort to improve the growth outlook.

 

Relations with China are strained as trade negotiations are at an impasse and China is intent on broadening its sphere of influence. Tension between the U.S. and Iran are elevated, particularly as the recent bombing of Saudi oil facilities has been tied to Iran. North Korea has shown no intent to slow the development of its nuclear program. Russia is committed to increasing its influence on the world stage. Brexit uncertainty leaves the U.K and the Eurozone in a state of flux. These issues all have the potential to inject short-term volatility into financial markets and impact the global growth outlook.

 

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