The past year has been characterised by a mixed environment for asset prices. The significant shifts that we have observed were mainly influenced by both the adopted and expected policy stances of major central banks. Initially, growing divergence between the US economy and major trading partners, coupled with increasing trade tensions and perceived higher geo-political risk, placed upward pressure on the US dollar (USD). The USD had also found support from the US Federal Reserve (Fed) continuing with its gradual path of monetary policy normalisation, while other major central banks lagged behind by keeping policy rates constant. US equities also outperformed their European and Japanese counterparts.
These developments resulted in emerging markets with relatively weak fundamentals, compounded by spillover effects from developments in Argentina and Turkey, seeing their currencies and financial assets coming under pressure. There was a discernible change in the final quarter of 2018 when indications of slowing economic activity in the US (against the background of already weak growth outside the US) led the market to anticipate a slower pace of Fed policy tightening and some downward pressure on the USD.
Concerns around a stronger than anticipated slowdown in global growth, together with geo-political developments, then led to a sharp increase in volatility and a correction in equity markets. The Chicago Board Options Exchange Volatility Index rose to a nine-month high of 36 index points in late December, while the S&P 500 fell by 9.2% during the same month. The MSCI All Country World Index, which includes both developed and emerging markets, also ended up recording its worst year in a decade by posting an 11.2% loss (although it has posted a 14% recovery year-to-date).
Around the same period, yields on 10-year bonds in the US and Germany declined, the latter to two-year lows as safe-haven demand increased. Turbulence in markets, alongside the expected fading effect of US fiscal stimulus, and slower growth in the eurozone, contributed to the significant change in monetary policy forward guidance given by the Fed and European Central Bank (ECB).
This has resulted in some easing in financial conditions and has been supportive of a rebound in risk assets in recent months. The Fed has pledged to be patient in respect of any further interest rate increases (with some market participants predicting the next move to actually be a cut), and to adjust the pace of balance sheet normalisation, while the ECB also changed course, delaying any previously envisaged interest rate adjustments to 2020 and committing to offer banks a new round of cheap loans to help revive the eurozone economy.
In addition, multilateral institutions have recently downgraded their economic growth projections. The International Monetary Fund (IMF) has, in its latest World Economic Outlook report1, pencilled in a 3.3% global growth forecast for this year, with an expected pickup in 2020 predicated on Chinese stimulus measures, improved market sentiment, dissipating temporary drags on euro-area growth, and stabilisation in certain stressed emerging market economies.
However, there are still uncertainties which will keep policymakers and market participants awake. Policy and political uncertainty will include geo-political developments, a possible disorderly Brexit, escalating trade tensions, and a sudden renewed tightening in financial conditions. The IMF has also flagged vulnerabilities stemming from China’s financial imbalances, volatile portfolio flows to emerging markets and fiscal challenges in some highly indebted European countries.
However, the expectation overall, even with the generally limited policy space, seem to be for a soft landing of the global economy rather than a recession.
By Daniel Mminele,
Deputy Governor of the South African Reserve Bank.