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.