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Developed markets have had a strong first quarter: the MSCI ACWI gained 7.5% during the February-April period, led by the US (9.3%) and the Eurozone (9.4%), while Emerging Markets (12% index weight) lagged with a mere 3.2% gain. What is more, some markets such as the S&P500 or the Nasdaq, surpassed their 2018 highs and reached new record levels.
The initial impetus for the rally stemmed from a ‘pivot’ in the stance of the Federal Reserve, which halted the planned rise of interest rates for 2019 and announced an earlier-than-expected end to its ‘quantitative tightening’ program (September 2019). It has since reaffirmed that it intends to remain on hold, albeit without giving indications that it would begin to ease as early as this year, in contrast to deeply engrained market expectations. Prior to the Fed pivot, China had already provided a series of stimulus measures – more balanced and measured than in past instances – that stabilized the Chinese economy, forestalled a more rapid deceleration and provided support for wider emerging markets.
A more dovish tilt of the other leading world central banks (e.g. the ECB) also helped reinforce the favourable market view towards risk assets. If this new found posture is maintained, allowing growth to stabilize at near trend levels, the key determinant for the remainder of the year is the outlook for trade relations, most notably those between the US and China but also between the US and Europe. In early May, President Trump first threatened and then implemented a new range of tariffs on imports from China, thus ending a temporary ’truce’ struck at a meeting with President Xi in Buenos Aires in November 2018.
Widening the net of affected imports to half of the total is estimated to reduce Chinese growth by 0.3% points this year and less than that for the US. This limited direct impact together with the widely held belief that the current impasse will be overcome (“it is in everyone’s interest”) has perhaps motivated the muted market reaction so far. On the other hand, market participants seem to also have come to accept that the wider ‘strategic competition’ between the incumbent and the emergent power is unlikely to dissipate in the near term. There certainly has been a correction in US stocks, a widening of spreads in credit and a pick-up in volatility. But these pale in comparison with the market reaction during previous such episodes last year. What is more, there are broader effects than the direct disruption of the global trade system: the impact on consumer confidence and business sentiment, the impact on investment and capex, the revision to business strategies for out-sourcing and supply chain integration, etc. In other words, markets may still be underpricing the potential risk to this ongoing feud and further downside price risk thus remains.
In sum, the change in policy tilt has managed to stabilize economic activity and provide the market with a strong uplift (in the US). With deterioration and countermeasure behind us, what lies ahead? First, note that while some headline figures have improved, the manufacturing sector (in the US and globally) still remains in the doldrums and capital expenditures remain soft. This precarious equilibrium is now being challenged by a renewed rise in trade tensions. Even if the current impasse (of early May) can be defused, it will likely not mark more than a mere ceasefire. What is more, what is at stake is the overall trajectory and destination of the international economic order. It may well be heading towards an equilibrium determined by ever more visceral nationalism and increasing protectionism.
*The publication reflects asset performance up to April 30, 2019, and macro events and data releases up to May 15, 2019, unless indicated otherwise.
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