In short, geopolitical concerns have added to stock market volatility – and
the U.S. Federal Reserve (Fed) has contributed to that volatility as well.
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
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
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.
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.
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.
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.
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.
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.
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.
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.
is Global Market Strategist at Invesco. This article first appeared in
the Invesco blog.
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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.