By Tim Fox
Financial markets have been dialling back on risk on two fronts: US-China trade and Brexit
Financial markets have seen a generalised dialling back of risk in the last month that is starting to cast doubt on the need for further monetary policy easing. Market optimism is improving on two key fronts, US-China trade and Brexit. As both issues have been the main sources of market uncertainty in 2019, signs of progress have the potential to transform sentiment. This optimism might still be premature, however, as a trade deal has not yet been concluded, not even a phase one deal, while Brexit still hangs in a delicate balance hostage to the outcome of a general election on 12th December.
Regionally, the improvement in risk sentiment is allowing Saudi Arabia to push ahead and launch the IPO of Aramco, but with further monetary easing in doubt this may also create headwinds for the non-oil private sectors. With rate cuts being one of the few positives for GCC growth so far this year, a premature end to the Fed’s easing cycle could potentially present complications going forward especially with OPEC driven oil production cuts likely to continue to weigh on overall activity in the region into Q1 2020 at least.
Despite the latest cut in US interest rates, for the third time since the summer, bond yields have risen as markets are viewing the Fed as pausing its rate cutting cycle from here, and are even beginning the process of pricing out the Fed completely in 2020. Signs that downside risks are subsiding were given further support by encouraging US growth data in Q3 and the latest October monthly jobs data. Both presented a picture of the downturn in the world’s biggest economy beginning to stabilise. This was something of a surprise as excluding the US the global picture remains quite challenging. China’s real GDP growth continued to slow in Q3, posting just 6 percent - the weakest expansion in some 30 years. The Eurozone may have avoided a contraction in Q3, and Germany a recession, but the timelier survey indicators are still pointing to weakness at the start of Q4.
Of course if the optimism about trade talks are justified then these economic clouds will begin to lessen over time. However, the omens here are more nuanced than the headlines might seem to suggest. Despite the warm words from President Trump about prospects for a phase one deal this month, Chinese policymakers are continuing to play hardball and demanding that tariffs on $360bn of Chinese goods are rolled back before they will sign a deal. And in the end, if the first phase of a trade deal is just about pulling back tariffs and buying more agricultural products (the symptoms of the dispute), then the core issues around which the trade dispute revolves (forced technology transfers, industrial subsidies, intellectual property theft) will still not have been addressed. This all suggests that completing phases two and three of a trade deal will be much harder and that trade tensions could easily revive over coming months. The same goes for Brexit, as for all the progress made recently in terms of the UK agreeing a deal with the EU, if the British elect another hung parliament next month the status of Brexit will be once again be in the air.
Considering these risks it is easy to see how the bases for the recent bouts of market optimism could easily reverse. Should that happen then the recent green shoots of economic data are also likely to be short lived, causing market expectations over interest rates to turn down again as well. For the GCC the resumption of easier monetary policies would probably be welcome in the current environment of low oil production and weak non-oil sector activity. However, it would probably be far better for all if the sources of easier monetary policies are properly resolved rather than just papered over by an empty trade deal and unsatisfactory solutions to issues such as Brexit.
* Tim Fox is Chief Economist at Emirates NBD