A string of data from the Eurozone is pointing to lower growth in the region. Sentiment was at a 2 year low, German business growth is expected to fall "well below" the 1.5% targets according to the central bank chief, and importantly, corporate lending in the region slowed.
According to the ECB, corporate lending declined in January exacerbating the downturn in the region. This is a start to the confirmation that the slowdown in the Eurozone is continuing and the moves by the ECB will have to be followed to see how they are able to react to these changes. The Fed chair is going into his second day of testimony to Congress, shedding more light on what the Fed is looking for in data and how they will react. The ECB will have to start thinking of what policy tools they can politically use in order to calm the fears of the Eurozone countries in the face of slower growth.
Markets are starting the week on a positive note. Talk of the trade tariffs being delayed has the Chinese stock market entering a bull market and the US futures are pointing to gains of around 50 basis points (half a percent) at the open. Oil prices are hitting highs for the year on supply cuts and optimism. Extending the increase in tariffs that were due to go into effect is a positive sign that normalization in trade can occur. This boosts the prospects for the economy as well as markets in which a normalized trade relationship with China (and other countries), with the help of an accommodative Fed, will produce steady tailwinds for 2019. This week Reality will test some of these assumptions.
Tuesday will start the week with a 2 day testimony by the Fed chairman. This will provide investors with more clarity on the stance of patience and data dependence for 2019. The US will also announce home prices and Crude oil stocks.
On Wednesday the Euro area announce business confidence numbers which will be important to determining if the slowdown in the region is more pronounced going into the final month for Brexit talks.
Thursday has GDP numbers coming out for many countries (including the US) as well as UK consumer confidence and German inflation. This will be a big check on the European Disunity play we are currently looking at. Whether the eurozone slowdown can be slowed, and eventually reversed, in the current political climate of the region. China's bull market will be tested with data, having the manufacturing PMI coming out. The numbers are expected to come in slightly below 50 (signaling a contraction).
Friday will see US numbers on Income and manufacturing which will be compared to the unemployment and inflation numbers of the euro area. Depending on how other regions report, this could show the US bucking a trend of slowing growth or falling in line (confirming the Fed's recent dovishness). Finalized PMI numbers will come out from the Euro Area which was barely in expansion at the last reading.
In Summary the market optimism we are seeing in the week will have the chance to continue should the week show the Fed taking precautionary steps with policy as US numbers still impress, China starting to see signs of strength in manufacturing to piggy back on trade talks, and the Euro area displaying resilient business confidence in the face of Brexit. If these assumptions seem lofty then we could start to see this Monday rally struggle as the start of March begins.
British unemployment stayed at 4% today with claimant counts being revised lower than expected. Construction output in the EU was not as upbeat, coming in lower than estimates. Thursday will see the EU PMI numbers come out which have been slowing down to the 50 range over the past 6 months (a number below 50 denotes a contraction). As Germany is flirting with a technical recession and Brexit looming, it will be important to see how the EU is affected by these trends. Some countries are better prepared for a slowdown (US) or have the ability to take decisive action fiscally and monetarily (UK), the Eurozone could struggle with the sense of unity and political will to counteract a slowdown.
US monetary policy:
As mentioned, the Fed has been raising rates in the past and now stands in a holding pattern to monitor the slowing growth around the globe. On Wednesday the FOMC minutes should shed some light on the recent trend towards monitoring the impact of past rate increases. An important measure is the change (if any) on the balance sheet reduction program. After buying up $4.5 trillion of assets during the financial crisis to boost liquidity, the Fed has been reducing the amount of assets it holds by about $40bln a month. A change in the level that the Fed sets as neutral will be important to the stability of debt levels and the Dollar.
There is a little over 6 weeks before the Brexit date is reached. Without a deal the UK risks falling out of the European Union without trade deals, or a solution on the border of Ireland. This would no doubt cause a lot of volatility in UK assets up to the departure date and beyond depending on the outcome. Since the vote to leave the EU in June of 2016 we have seen the effects of the decision on the currency, markets, and economic numbers. As an investor with a longer horizon, how should you look at these events as they unfold and uncertainty depresses prices.
Looking at the headlines it seems the Eurozone is the obvious winner if the UK suffers a hard exit. Goods from the UK to mainland Europe are small in comparison and many companies have already started to move staff and jobs out of Britain. Looking at the overall economic growth globally the Eurozone might not fare as well as many expect. Aside from the Brexit uncertainty global growth is slowing down and the Eurozone is no immune. In the event of a slowdown the UK is in a better position to provide stimulus to their economy and the depressed Pound will help with exports.
The Eurozone didn't see the economic decline that the UK did after the vote to leave, but since the slowdown started, the Euro countries were hit hard by their intertwined bonds and banking system and the end of massive QE stimulus. One of the major themes we are following is European Disunity, a slowdown in growth and the lack of political will for more monetary accommodation, many of the countries are starting to undertake fiscal stimulus. This is a good sign that the European governments are aware of the problems, but it raises the concerns about which countries can afford to add a lot of stimulus and which cannot. This could create the two speed Europe we have seen in the past, only this time the ECB could have mixed data on their hands.
While Brexit is not great for the UK and will see volatility in the coming months, take into account the larger economic trends and who would be most likely to manage and come out of an economic slowdown quickly, should one occur. In this scenario the UK looks much more nimble and has the ability for more monetary and fiscal stimulus. Now would be the time to sit back and wait to start buying.
US markets have rallied back pretty well at the start of this year, with the S&P500 up over 10% it seems that there is a nice comeback to the market sell-off we had in December. Earnings were not as stellar as in the past so that can't account for the upswing, and trade tensions, Brexit, and a global slowdown are still on the table. The one factor that seems to be putting the market on an upward trend is the change in Fed policy. Since the start of the year the Fed has been pushing a message of patience and concern over the rate of increases that it was set to make in 2019. Since the start of December the probability of an increase in 2019 virtually disappeared, in fact a rate cut of 25 basis points is starting to creep back on the table.
The concern about this current situation is that there is a great emphasis on the actual news of the Fed taking it slower in its tightening policy but the events that are causing the concern are still being priced in as remote. The global slowdown, trade tensions, and Brexit have yet to materialize into real crisis. If you look at the economic data coming out of the US it is still surprising to the upside. This is giving the impression of a strong economy with the Fed easing. These two issues are not going to remain intact for long. The concerns facing the global economy are going to start affecting the US proving the Fed early to react, of the US will in fact weather all of these global concerns somehow at which time the Fed will most likely reverse their tone rather quickly.