5th December 2018

What a difference a week can make. Having been some way off normalised rates only a few days ago, now (apparently) we are almost there. While some market participants may feel vindicated in their prediction of a change in pace from the Fed, there are still a number of questions to be answered before the ‘doves’ can claim victory.

1 – Are the fed now more dovish?

The market is no longer pricing anything like 3 hikes next year. In fact current consensus would probably suggest one more hike in 2019 and that’s it.  However, if we believe the Fed’s own assertion that the neutral rate resides somewhere between 2.5% and 3.5% and add the fact that Powell did not say his view of neutral rates had changed, then we cannot automatically preclude 3 more rate hikes after December’s at all. It is clear however that recent communication from Powell was likely intended to come across as dovish and would certainly suggest a more data dependent Fed moving forward.

2 – What has changed between October and November for Fed Chairman Powell?

There are a number of factors are at play here. Firstly some leading economic data is pointing towards a general slowdown in global economic conditions. On top of this there has been a weakening in broader asset pricing across a range of asset classes. The significant drop in oil prices will likely follow through into some of the Fed’s inflation gauges which, in the absence of continued wage increases, indicates the overall outlook may be weaker than expected. Trump’s comments about the Fed can’t have helped but I don’t expect they had any real influence. Realistically US growth has fallen from 4.2% to 3.5% over the course of the 2nd and 3rd quarters and may continue to weaken in the months ahead in our view.

3- How will this affect asset prices and rates?

Critically this will not stop the overall tightening of economic conditions. Growth we believe will continue to weaken with QT contributing to ever-tighter liquidity conditions. The biggest issue however for the global economy is in relation to the US Dollar. If we can see a continuation of the stabilisation of the dollar and even potentially a fall in its trade weighted value, this can help certain assets classes like commodities and local Emerging Markets.

Equities and credit may receive a short-term boost, however, medium term the structure of these markets will need a flow event (either a monetary or economic upside surprise), which we think is still some way off. December may produce another Christmas bonanza to help many managers who are currently under water for the year post returns in the black again. Looking into 2019 we would probably need a real shift in the dollar lower to support global growth again and that might only come if the US economic conditions start to surprise on the downside.

End of cycle trading is difficult at best. The Fed may be willing to scale back its rate hiking programme, but that will be far from enough to prevent the eventual end of this cycle which has seen a proliferation of debt far greater than any other time in history. Whilst there is the possibility that this can be postponed until 2020, 2019 is certainly becoming more of a concern for global investors.


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