What a difference a month makes! In April, the U.S.- China
trade negotiations were anticipated to wrap up; U.S. relations with Mexico and
Canada were on the mend, and U.S. trade negotiations with Europe were not
anticipated to cause too much trouble, at least in the short term. Come May,
none of these things happened; indeed, they all deteriorated.
Not surprisingly, developed market government bonds rallied significantly; what was more surprising was that peripheral European and emerging market local government bond yields also rallied. Indeed, on our count, ALL bond markets rallied except for Italy and South Africa. Credit markets did not fare as well, though, with both investment grade and high yield spreads widening, but not to the extent that might have been expected. Lastly, the dollar strengthened across the board. Déjà vu? Maybe not.
The January “Powell Pivot”
is key to understanding market behavior in May and beyond. The big difference
from last year is that the U.S. Federal Reserve (Fed) is in play. We have already
seen central banks in New Zealand and Australia cut rates in recent weeks. With
few signs of a rebound in the macroeconomic data (just about everywhere) and
downside risks to growth growing due to the escalating trade war, the
probability of a Fed ease is rising steadily, as it is for most central banks.
This is supportive for government bond markets, credit markets and equities
(but not supportive of the dollar).
Thus, market developments should be materially different from the fourth quarter of 2018. We do not believe a recession either in the U.S., Europe or globally will occur UNLESS unemployment rates start rising and households retrench. This makes government bonds look expensive relative to current conditions; but markets are forward-looking and have correctly anticipated deteriorating global conditions. Until proven wrong, markets will likely keep on their current trajectory. Conclusion: Keep one eye on the U.S. consumer and one eye on Chinese policymakers (oh, and don’t forget to keep that third eye on trade negotiations!). Things should be OK, but better to be prudent and not be too bullish or bearish.
Display 1: Asset Performance Year-To-Date
Quelle: Morgan Stanley