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Five worries hanging over global markets
11/13/2018 6:02:27 PM
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By Fund Library News Wire  | Wednesday, October 24, 2018


 



By Kristina Hooper, Global Market Strategist, Invesco Ltd.

There was no rest for the weary last week, as geopolitical developments came fast and furious, and capital markets reacted. Below, I cover five important issues that have continued to contribute to stock market volatility – some of which flew under the radar during the week’s flood of news – and highlight five issues to watch this week.

Five issues rattling the markets

In short, geopolitical concerns have added to stock market volatility – and the U.S. Federal Reserve (Fed) has contributed to that volatility as well.

1. Trump delivers another obstacle to U.S.-China trade.

Of course, trade was at the epicenter of volatility. President Donald Trump announced that the U.S. would be excluding China from its 144-year old Universal Postal Union Treaty, an agreement that allows small packages from around the world to be shipped to other countries at a very low rate. This is intended to be yet another weapon in the U.S.’ trade war with China – one that makes it much more difficult for Chinese businesses to sell smaller items direct to U.S. consumers. This treaty makes shipping products into the U.S. from other countries artificially inexpensive, so one could argue that it is a legitimate issue for the Trump administration to raise. However, to suddenly declare such a change is very complicated. The Universal Postal Union (UPU) is a United Nations agency, and virtually every country around the globe is a member. So this apparently means that the UPU will need to negotiate new terms with all those members. It seems the likely impact could be a significant increase in costs to U.S. consumers – and of course a drop in sales for Chinese companies. This news placed additional pressure on Chinese stocks – albeit very short-term pressure.

2. Preparations begin for U.S.-EU trade talks

Another important development that didn’t receive much attention has to do with the trade relationship between the U.S. and European Union (EU). On Oct. 16, the Trump administration notified Congress that formal trade talks will begin between the U.S. and the EU. However, it is interesting to note that the EU’s lead trade negotiator, Cecilia Malmstrom, has yet to do the same with the EU, which underscores that not all EU members seem to want such a broad scope for the negotiations. At this point, lower-level EU officials will meet in Washington this week as part of preparations for a late-November meeting between Malmstrom and U.S. Trade Representative Robert Lighthizer. It appears these trade talks could be acrimonious, given recent criticism from the Trump administration that European trade policies are unfair – as well as Trump’s repeated assertion that the EU was created to take advantage of the United States. The key takeaway is that a trade agreement between the EU and the U.S. will not be easy; it is far from a “done deal.”

3. Brexit deadline nears, with no deal in sight

Time marches on, yet there is still no Brexit deal. It seems that the U.K. may soon need to focus more effort on developing contingency plans for a “no deal” Brexit and getting an extension on its transition period. What I worry about most is the rising economic policy uncertainty that comes with this inability to reach an agreement. Businesses are growing increasingly uncertain about what will happen after March 29, 2019, and I expect this to be a negative for business investment and hiring between now and then.

4. Tensions in Saudi Arabia could affect oil prices

The plot continues to thicken vis à vis the death of a Saudi journalist at the Turkish embassy, and the situation has significant ramifications for foreign relations and the price of oil – and more. For energy markets, the Saudi situation could be particularly disruptive now that the U.S. has withdrawn from the Iran nuclear accord and can no longer purchase Iranian oil supplies.

5. Fed policies have continued to raise concerns

Trump stated last week that he believes his biggest threat is the Fed – and I would agree that the Fed poses a significant risk. The most recent Federal Open Market Committee (FOMC) minutes, released last week, indicate that a number of FOMC participants “judged that it would be necessary to temporarily raise the federal funds rate above their assessments of its longer-run level.” That really isn’t a surprise, given that the “dot plot” has already been reflecting this policy prescription, but what makes it a significant risk is that this is occurring at the same time that the Fed is unwinding the balance sheet at an accelerating pace.

Five things to watch this week

* EU’s response to Italy’s budget. In the wake of submitting a less-than-frugal budget that violates Italy’s agreement with the EU, Italy’s sovereign bonds sold off, with the yield on the 10-year rising to a 3.69% close last week.1 The Italian bond selloff spread to peripheral bonds – Greece, Portugal, and Spain. We are watching how the situation unfolds. Italy already appears to be more conciliatory in its language, optimistically suggesting it may spend less than budgeted for 2019. I suspect an outright conflict will be averted as the EU will probably harshly scold Italy, but ultimately allow it a pass for the 2019 budget – and of course demand greater fiscal discipline in 2020. In my view, the EU can’t afford a standoff with Italy as it is waist-deep in negotiations with the U.K. and may be facing trade friction with the U.S.

* Positive environment for Chinese stocks. After coming under pressure last week because of the U.S.’ Universal Postal Union action as well as a lower-than-expected gross domestic product (GDP) print, Chinese stocks experienced very strong performance at the start of this week, rallying on President Xi Jinping’s commitment to provide “unwavering” support for non-state firms. This should bring back memories of a similar commitment by European Central Bank (ECB) President Mario Draghi back in 2012 to do “whatever it takes” to support the euro. Draghi’s statement worked, as systemic stress in the eurozone decreased and stocks rose. We will want to follow the market reaction going forward, although I expect Xi’s comments to continue to have a positive effect.

* A big week for central bank expectations. The central banks of Indonesia, Canada, and Turkey will all be meeting this week. As expected, Canada raised its policy rate to 1.75%. The path was recently cleared for a rate hike when Canada reached an agreement on the trilateral U.S.-Mexico-Canada trade deal (USMCA), which replaced the North American Free Trade Agreement and removed a key risk facing its economy. Other risks remain, however, and I believe Canada’s substantial household debt poses a risk as rates rise. The European Central Bank (ECB) is also meeting this week and is expected to confirm it will end tapering by the end of this year. I am skeptical that the ECB will actually do that, given all the geopolitical uncertainty currently facing the EU. We will certainly want to scrutinize the language from Canada and the EU closely.

* The price of gold. Gold rallied last week, breaking clear of its recent trading range. It seems that geopolitical risks – and perhaps also concerns about rising inflation – are finally placing some upward pressure on gold prices. We will want to follow the price of gold closely, as I believe it will give us insight into how worried investors are becoming about current developments such as trade and Saudi Arabia. I believe we will also see fear reflected in the 10-year Treasury yield if the geopolitical situation worsens.

* Earnings. This will be the busiest earnings reporting week for the third quarter. I expect continued good news in general about the third quarter. However, I am listening carefully for comments on the outlook for these companies – especially with regard to trade issues including supply chain disruption.

1. Source: Bloomberg, L.P.

Kristina Hooper is Global Market Strategist at Invesco. This article first appeared in the Invesco blog.

Subscribe to the Invesco Canada blog and get Kristina Hooper’s market reviews in your inbox.

Important information

The Federal Reserve’s “dot plot” is a chart that the central bank uses to illustrate its outlook for the path of interest rates.

Gross domestic product is a broad indicator of a region’s economic activity, measuring the monetary value of all the finished goods and services produced in that region over a specified period of time.

In a “no-deal” Brexit, the UK would leave the EU in March 2019 with no formal agreement outlining the terms of their relationship.

The opinions referenced above are those of Kristina Hooper as of Oct. 22, 2018. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.

© 2018 Invesco Ltd. All rights reserved. Used with permission.

 
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