Despite a burst of volatility early in August – not uncommon in markets – the equity bull run barrels on for an 11th year.
But the mood is far from buoyant as fears of a sudden slowdown in the Chinese economy have risen, clearly exacerbated by the ongoing trade war. Closer to home, Brexit remains as unresolved as ever. A new occupant in Number 10 Downing Street will act as a catalyst, but to what end?
The global economy faces headwinds; however, consumer spending and services remain strong. And given low inflation, central banks have signalled easier policy ahead and government budget policies are being adjusted to shore up growth prospects.
Downside risks continue to loom over the global economy, which along with financial markets faces two major event risks – trade war escalation and a “no-deal” Brexit. These factors have already begun to hit global trade, where there has been no growth in volumes over the past year, and on UK business confidence, which has dipped into contraction territory.
Boris Johnson’s ascension to prime minister signals a new phase in the UK’s Brexit negotiations, where a hard “no deal” is possible. These factors have hit business confidence, particularly in manufacturing, and corporate investment plans. However, services and consumer spending show little sign of weakening, unemployment is falling steadily across the euro zone, and wages are rising steadily in real terms.
Fiscal policy has turned easier across the globe. Ever since the Federal Reserve’s last rate hike in December, central banks have performed a U-turn in forward guidance on policy. It now looks likely that rate cuts, asset purchases and refinancing facilities for banks will combine to create a more supportive backdrop for the economy.
Much attention has been paid in recent months to US recession indicators flashing warning signals. These models are typically based on observations of differentials in Treasury yields – long-term yields often dip below short rates ahead of recessions. However, we would caution that global government bond markets continue to be influenced by central bank asset purchase programmes, which may reduce the reliability of such models.
However, economic slowdowns do not always lead to recessions – these tend to occur when economies face major imbalances, such as a rapid build-up in private-sector debt, or cyclical excesses in sectors such as housing. Today, there are areas for concern, but by and large economic and financial imbalances do not seem extreme, and banks are well-capitalised.
Perhaps most importantly, economic slowdowns can last for years, and usually tend to be favourable environments for risk-taking. Should some of the risk events dissipate, conditions may even turn around, with a global expansion resuming.
Chris Thomson, head of Kleinwort Hambros, Edinburgh Office