“The global economy is flying on one engine, with manufacturing in recession and services keeping the economy airborne.”
Each time central banks attempt to normalise monetary policy, the “market gods” compel them to revert to easing mode and lower rates. This is a result of the era of economic slowbalisation that we are now living in.
The global economy is flying on one engine, with manufacturing in recession and services keeping the economy airborne. Populism-driven fiscal stimulus is keeping services afloat for now and central banks are doing everything possible to support their economies. While the risks of an economic recession are low, an earnings recession could end up happening if economic activity does not pick up in the second half of this year or a trade deal is not reached. This is because the fate of equity markets tends to be linked to the manufacturing sector, while the strength of the economy is more closely tied to services. Therefore as far as global growth is concerned, we are still comfortable for the time being, although we may see equities struggle as multiples are difficult to expand in a low earnings growth environment. Central banks will try to bring confidence back to consumers in an effort to prolong the cycle but equities may not do as well as in the recent past. For markets, the key factor in their favour is the absence of exuberance. Indeed, this rally is unique in that equity markets have reached new all- time highs at the same time as USD 150bn have flowed out of equity funds.
Monetary policy looks trapped in a looser for longer cycle, making credits look more attractive, especially on a risk-adjusted basis. The Fed has further room to run, versus the ECB and BoJ, who have less effective tools left in their monetary policy toolkits. Because of this, the dollar might end up weakening, which would continue to support gold prices and emerging- market currencies. We doubt that the “market gods” will relieve the central bank Sisyphuses in the end and allow for monetary policy to normalise. Should this fail to translate into positive economic growth, we could eventually see more direct fiscal easing from more populist governments. Of interest as the US presidential election season kicks off is who the Democratic nominee will be and what his or her proposed policies are, particularly as we could see Modern Monetary Theory discussions take centre stage.