Still positioned for a sideways market
Sébastien Galy, Sr. Macro Strategist, Nordea Asset Management
We expect the economic slowdown to spread till the first half of 2020 before China leads a moderate economic rebound that should slowly extend into 2021. This means that our theme of “Japanification” with a heavy focus on fixed income continues, but there eventually will be rising opportunities in equities preceded by those in emerging markets.
A full cycle of Fed rate cut rather than a mid-cycle correction
The Emerging Markets (EM) slowdown had an outsized impact on US manufacturing fed by stories of a US recession that have been propagated through investment banks and the media. The result is that the confidence of US conference board CEOs is close to an all-time low, with very negative consequences on the economy. This shock is starting to impact consumers, who are spending less than expected at a time when government spending and especially trade is not helping. We expect this contagion to spread and consumer savings to rise as this deleterious story takes hold though a US/China trade deal in Q1 2020 should help to reverse the situation.
The odds are therefore that the Federal Reserve will go for a full cycle of easing rather than a mid-cycle correction. The Fed fund rate currently expects 71 basis points in rate cuts by the end of 2020. The odds are we’ll see a rate cut in December and that by mid-2020, Fed fund rate cuts will have fallen to around 50 basis points. Given that this is a purely temporary shock, we expect a rapid economic rebound and by mid-2021, when the Fed should be on a path of tightening once again. The pace of tightening should be slow under Democrats as we will likely be in a fiscal contraction given pressure from Republicans to rein in spending.
The impact on the dollar versus emerging markets and EM hard and local currency fixed income should be quite positive for these asset classes. The impact on equities should be mixed to positive for defensive stocks as it reduces their financing costs (e.g. utilities) while the demand shock should initially hurt cyclicals and growth stocks. Such a complex world is one for managed US equities and fixed income. Finally, the dearth of safe havens, including higher yielding US Treasury, should drive the demand for safe-haven assets from Japanese Government Bonds to European Covered Bonds, particularly in Italy and Greece.