2nd Quarter 2019
The global economic slowdown continues, but we expect it to stabilise over the next six months.
The US bond market is signalling increased risk of recession.
Policy rates are not expected to rise in the US, Switzerland or the eurozone in 2019.
Equity markets are benefiting from the end of monetary policy normalisation.
Political risks are taking centre stage.
Central banks in the US and Europe have limited room for manoeuvre to counter any potential recession.
The slowdown of economic momentum globally is apparent in the disappointing data. The prospects remain clouded given the lack of any clear signs of a reversal in the leading indicators.
The Global Purchasing Manager's Index (PMI) for manufacturing and service sectors recovered slightly in February, but initial estimations for March point to further deterioration. For manufacturing in particular it would appear that the decline is not yet over. The eurozone manufacturing PMI seems to have fallen to a six-year low in March. A slowdown has also been apparent in the manufacturing sector in China for months. Momentum has slowed down in the USA too but, in contrast to China and Europe the Purchasing Manager's Index for the USA is still above the growth threshold of 50 points.
In light of the disappointing data forecasts for world economic growth have continually been revised downwards since mid-2018. The consensus forecast by Bloomberg for global GDP growth in 2019 was still 3.70% nine months ago, while the latest projections see growth at 3.40%. Provided that risks of a no-deal Brexit or an escalation in the trade dispute do not materialise, we expect global growth to stabilise over the next sixth months.
Moderate GDP growth is anticipated for the US in the first quarter, partially due to the government shutdown, which persisted until 25 January. The Congressional Budget Office estimates that the shutdown reduced annualised GDP growth rate by 0.4 percentage points in the first quarter. This effect is likely to be partly offset in the following quarters. Growth for the year is therefore likely to remain solid again, even if slightly lower than the year before. The robust labour market bolsters consumption but, in turn, the expansionary effect of tax reform will come to an end.
In the eurozone, uncertainties such as Brexit and the global trade conflict dampen sentiment and therefore economic momentum. We however assume that these uncertainties will be resolved in the coming months. In France the economic climate has already brightened. The accommodative monetary policy should also boost domestic demand.
For Switzerland the KOF Economic Barometer is indicating below-average growth. Foreign trade in particular is suffering under the global economic slowdown.
The economic slowdown in China is expected to stabilise thanks to the fiscal measures initiated by the government.
However, risks for the global economy still remain. Trade negotiations between China and the US should be monitored closely. Market consensus is that a speedy resolution will be found. In light of the economic slowdown in China, an escalation of the dispute would likely trigger renewed market turbulence. Meanwhile, Brexit is currently the greatest source of uncertainty in Europe. But with the end of monetary policy normalisation in the US and the EU one significant risk factors has been mitigated over the last month.
Review: While long-term interest rates fell to a several year-low in an environment marred by risk-aversion up to the start of 2019, this was followed by a sideways trend which continued until the start of March. Then, weaker economic data, very “dovish” statements from the central banks and the confusion around Brexit led to a further decline in interest rates. The yield on ten-year government bonds in the US fell by another 32 basis points to 2.39% in March, sometimes even dipping below the money market rate of 2.375%. Following several year-lows in Germany and Switzerland the ten-year returns again fell considerably to -0.07% and -0.39% respectively. As such, the interest rate is currently only slightly above the all-time low of mid-2016.
In this environment one would typically expect the credit spreads of corporate bonds to widen. But currently, the opposite is true. US BBB spreads have narrowed by almost 40 basis points since the start of the year. This is due to desperate attempts by investors in search of yield. In contrast to this, negative interest rates in Switzerland are leading to a slight increase in credit spreads in some cases. This is because investors are not prepared to buy negative-return corporate bonds; to compensate for the decline in interest rates, spreads must increase until the yields reach at least zero in total.
Outlook: The US Federal Reserve (Fed) indicated that it would likely not raise its policy rate in 2019. Financial market participants are actually a rate cut for later this year. It has also been announced that the Federal Reserve will cease attempts to reduce its balance sheet as of September.
The European Central Bank (ECB) announced the third round of the so-called “TLTRO programme”. This will see EU banks continue to be offered low-cost loans from the central bank. Discussion is also underway at the moment as to whether the negative deposit rate should be staggered to alleviate its harmful effects on the European banking sector.
The Swiss National Bank (SNB) has reduced its inflation forecasts. It also still considers the Swiss franc as highly valued. This, combined with a cautious ECB, suggests that monetary policy normalisation in Switzerland is still a long way off.
If these weak economic figures are not the precursor to a recession, but just a dip in growth, then the current interest level is far too low. A countermovement in long-term interest rates is likely in this case. Credit spreads are likely to remain at their current low levels in the short term due to the hunt for yield. In the medium term however the market seems too reliant on the assistance of the central banks. After all, even if it were a dip in growth, cyclical companies in the lower credit rating segment would likely have difficultly reducing their debt burdens. In our opinion, at the current level the spreads are not damaging enough for this risk.
For the first time since the financial crisis the interest rate for ten-year US government bonds fell below that of three-month money market instruments at the end of March. This is often interpreted as a sign of a recession, after all, the US yield curve inverted before every US recession. However, not every inversion has been followed by recession. Nonetheless, the spread between ten-year US government bonds and three-month money market instruments is a decent indicator for estimating the probability of a recession (see Chart 3). The likelihood of a recession in the US in 2020 is currently approximately 24%. In the past recessions have not come about until a probability of more than 30%.
Unlike the central banks in Europe or Japan, the Fed has been able to raise interest rates significantly over the past few years. But even for the Fed there would be little room for manoeuvre if it were to come to a recession next year. In the past, the Fed has been reducing its policy rate by an average of 615 basis points during a loosening cycle. At the moment, the Fed is only 250 basis points away from the zero lower bound. If this were reached, a switch back to bond purchases or the introduction of negative interest rates would have to be considered.
Review Q1: After the steep price declines at the end of 2018, a rally set in in January, bolstered by US monetary policy and an easing of US trade policy. The US Federal Reserve, which indicated two more interest rate increases for 2019 in December 2018, reassured investors in January when it announced a pause in the rate hiking cycle. In February, US President Donald Trump withdrew the threat of additional import customs on Chinese goods. In March, the Fed indicated that there would be no additional rate hikes this year. Following the disappointing economic data from Europe and the inversion of the US yield curve, fears of a recession re-emerged at the end of March. Overall, two-figure price gains were posted in the US, the eurozone and Switzerland. The S&P 500 gained roughly 14%, the Euro Stoxx 50 grew by 12% and the SMI almost 12%.
Outlook: In the short- to medium-term we expect a constructive environment for stocks amid expansionary monetary policy. In longer-term however earnings growth is likely to be weaker than in previous years. This is due to the slowing economic momentum (see Chart 5) on the one hand, and the pressure exerted on profit margins by rising wages on the other. The latter is likely to be the case primarily in the US, where wage growth of 3.4% in February again exceeded the expectations of analysts. We therefore expect a weaker stock market performance over the next twelve months.
Review Q1: The exchange rate of the Swiss franc to the euro and to the US dollar was relatively stable in the first three months of the year. The euro appreciated by 0.8% against the Swiss franc, while the US dollar gained roughly 1.3% in value. The British pound on the other hand grew by almost 4%. Therefore it would appear that, up until now, investors have not been anticipating a disorderly Brexit.
Outlook: Given the expected stabilisation of economic development in the eurozone, the euro is expected to appreciate slightly against the Swiss franc over the next 12 months and move towards the 1.17 mark, which would correspond to a fair value in accordance with purchasing power parity. In the event of a disorderly Brexit however we would see a significant appreciation of the Swiss franc against the euro and specifically against the British pound.
The strength of the US dollar was favoured in 2018 by the positive US economic data and the rising interest rate differential. Given that these driving forces are diminishing this year, we expect a slightly weaker US dollar over the next 12 months.
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