The U.S. Federal Reserve’s dovish turn pushes recession risks out to 2020, but we think it is premature to expect the next move to be an easing. Global cycle conditions are improving at the margin and inflation is still in the long-term pipeline.
Calm after the storm
It’s been an eventful few months. The S&P 500® Index narrowly avoided a bear market and bounced back strongly. Brexit is on a knife-edge, the China/U.S. trade negotiations are still unresolved (although sounding more positive) and markets have shifted from expecting the U.S. Federal Reserve (the Fed) to hike its funds rate several more times to now anticipating the next move as an easing.
Our cycle, value and sentiment investment process identified a buying opportunity for global equities in early January when market panic hit an extreme and became strongly oversold.
The oversold signals have now faded, and our process is holding us at a broadly neutral weighting on global equities. The process favours non-U.S. over the U.S. mostly because of valuation. The U.S. is expensive while Japan, Europe and emerging markets are close to fair value. Inflation pressures and the unwinding of central bank balance sheet expansion mean the cycle is a modest headwind for government bonds.
Paul Eitelman argues that the Fed pause will help extend the U.S. economic expansion. He sees signs that the data weakness of the past few months is turning around and thinks markets have overreacted by pricing in Fed easing.
Andrew Pease thinks European growth is set to improve during 2019 as the impact of one-off events fade and fiscal stimulus provides a tailwind. These one-offs include a rebound in German motor vehicle production, the thaw in the global trade war, calmer political conditions in Italy, the winding down of the French yellow-vest protests and a resolution to the Brexit dramas.
Alex Cousley is looking for China policy stimulus to provide a boost to the Asia-Pacific region. He thinks the data weakness in Japan is unlikely to be sustained but has increased the dovish bias at the Bank of Japan. The housing downturn is creating downside risks for Australia, but Alex thinks the hurdle for Reserve Bank of Australia easing is high with the prospect of fiscal stimulus ahead of the federal election in May.
Van Luu and Max Stainton think the U.S. dollar can stage a further rally once investors see that pessimism on the U.S. economy is overdone.
The recession probabilities from the U.S. business cycle index model estimated by Kara Ng have trended higher over the past couple of months. Kara thinks much of this is due to transitory factors such as the government shutdown, weather and trade-war uncertainties. We will be watching this model closely in the coming months to see whether recession probabilities recede once the transitory factors fade from the data.