In the absence of a big China stimulus, guess who steps in?
As the two major headwinds from last year - a slowing China and tighter financial conditions - continue to weigh on the global economy in 2019, central banks are yet again trying to come to the rescue. Having realised another big China stimulus is not forthcoming, plans for policy normalisation have been universally suspended. Suddenly, we are back to the land of wait and see.
Of course, the Fed has been the major force driving the ‘dovish pivot’ in global monetary policy. While the overall policy direction was in line with my view, I had completely underestimated the pace and the degree of the pivot - from the now infamous ‘this cycle can last indefinitely’ in October to the need for ‘patience’ in January to ‘no more 2019 hikes’ in March, with the end of quantitative tightening by September thrown in for a good measure.
The reason? No, it’s not the domestic economy that is the main concern. In fact, the Fed’s economic outlook is ‘favourable’, with growth projected to stay above trend. Rather the external risks - such as China, Brexit and trade issues - apparently formed the drivers behind the dramatic policy pivot. Ironically, external risks at the end of last year were arguably higher - or at least not lower - than they are today. Puzzling indeed.
My take on the recent changes to the Fed’s reaction function, its policy response to economic conditions, is as follows. Firstly, it has become highly reactive to incoming economic data. Secondly, it now puts less weight on unemployment and more on inflation (we will probably find out in June the exact framework the Fed is shifting towards, but average inflation targeting seems the most likely at this point). Lastly, it is becoming more global. This final point is a tough one for the Fed to make explicitly for political reasons, but by implicitly targeting financial conditions, the Fed acknowledges the importance of global factors. Partly in the face of apparent policy restraint in China and the related drag on other economies, the Fed had to step in, abruptly suspending monetary policy normalisation.
What to expect from the Fed next
The rules of the game are clearly in flux. It’s not easy forming a high-conviction, evidence-based view on the Fed’s path from here. I still believe, however, that the market has over-reacted by pricing in rates cuts, which only come into play in conjunction with stronger evidence of a recessionary trajectory. And while weakness in the first quarter this year is undeniable, I still believe this is a soft patch within the overall adjustment to a lower growth rate more in line with its trend.
Over the past month US data has been somewhat mixed but still undoubtedly pointing to slower economic momentum. However, there are some positive signs suggesting this cycle can extend for a bit longer, even if at an unspectacular pace. Despite concerns about yield curve inversion, the probability of a recession in the next 12 months remains low.
I expect signs of stabilisation after the sharp first-quarter slowdown to emerge. In this scenario it will become increasingly difficult for the Fed to stick to its current stance. One factor to keep an eye on is whether higher wages finally start to push up prices. How much of an overshoot to the inflation target could the Fed tolerate before switching stance?
With this in mind, I believe the Fed is not done. The next hike might not be this December (it’s hard to ‘fight the Fed dot plot’ but who knows), but it could well be in early 2020. Of course, to engineer the pivot back, without causing big market tantrums, the Fed would have to start tweaking the message well before that. For those thinking the Fed will remain on the side lines until next year, 2019 should still have a few surprises in store.
What question should we tackle next?
Email your suggestion email@example.com
The value of investments and the income from them can go down as well as up so you may get back less than you invest. Past performance is not a reliable indicator of future results.
These materials are provided for information purposes only and are intended only for the person or entity to which it is sent.
These materials do not constitute a distribution, an offer or solicitation to engage the investment management services of Fidelity, or an offer to buy or sell or the solicitation of any offer to buy or sell any securities or investment product.
Fidelity makes no representations that the contents are appropriate for use in all locations or that the transactions or services discussed are available or appropriate for sale or use in all jurisdictions or countries or by all investors or counterparties.
Investors should also note that the views expressed may no longer be current and may have already been acted upon by Fidelity. They are valid only as of the date indicated and are subject to change without notice.
This material was created by Fidelity International. It must not be reproduced or circulated to any other party without prior permission of Fidelity.
This communication is not directed at and must not be acted on by persons inside the United States and is otherwise only directed at persons residing in jurisdictions where the relevant funds are authorised for distribution or where no such authorisation is required. Fidelity is not authorised to manage or distribute investment funds or products in, or to provide investment management or advisory services to persons resident in, mainland China. All persons and entities accessing the information do so on their own initiative and are responsible for compliance with applicable local laws and regulations and should consult their professional advisers.
This content may contain materials from third-parties which are supplied by companies that are not affiliated with any Fidelity entity (Third-Party Content). Fidelity has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content.
Fidelity International refers to the group of companies which form the global investment management organisation that provides products and services in designated jurisdictions outside of North America Fidelity, Fidelity International, the Fidelity International logo and F symbol are trademarks of FIL Limited. Fidelity only offers information on products and services and does not provide investment advice personal recommendations based on individual circumstances.
Issued in Europe: Issued by FIL Investments International (FCA registered number 122170) a firm authorised and regulated by the Financial Conduct Authority, FIL (Luxembourg) S.A., authorised and supervised by the CSSF (Commission de Surveillance du Secteur Financier) and FIL Investment Switzerland AG, authorised and supervised by the Swiss Financial Market Supervisory Authority FINMA. For German wholesale clients issued by FIL Investment Services GmbH, Kastanienhöhe 1, 61476 Kronberg im Taunus. For German institutional clients issued by FIL Investments International – Niederlassung Frankfurt.
In Hong Kong, this content is issued by FIL Investment Management (Hong Kong) Limited and it has not been reviewed by the Securities and Future Commission. FIL Investment Management (Singapore) Limited (Co. Reg. No: 199006300E) is the legal representative of Fidelity International in Singapore. FIL Asset Management (Korea) Limited is the legal representative of Fidelity International in Korea. In Taiwan, independently operated by FIL Securities (Taiwan ) Limited, 11F, 68 Zhongxiao East Road, Section 5, Xinyi Dist., Taipei City, Taiwan 11065, R.O.C. Customer Service Number: 0800-00-9911#2.
Issued in Australia by Fidelity Responsible Entity (Australia) Limited ABN 33 148 059 009, AFSL No. 409340 (“Fidelity Australia”). This material has not been prepared specifically for Australian investors and may contain information which is not prepared in accordance with Australian law.