Elga explains why we see a growth pickup looming on the horizon. Hint: Watch the transmission of financial conditions.
An expected dovish pivot by central banks has materialized. Now what? Financial conditions in key developed economies have become more accommodative as a result, even though the lift to the broader economy has yet to kick in. We see policy easing helping sustain the economic expansion–and the likelihood of a growth pickup over the next six to 12 months. This supports our moderate pro-risk stance. Yet it could be a bumpy ride due to the persistent uncertainty from protectionist policies.
Growth expectations for key developed economies have faltered since 2018, as indicated by our BlackRock Growth GPS for G3 economies (the U.S., Japan and euro area). Financial conditions have eased in recent months in these economies thanks to policy easing, according to our Financial Conditions Indicator (FCI). The historical relationship between our FCI and GPS points to potential for a growth pickup in the coming six months. Some pockets of the economy that are more sensitive to interest rates appear to be slowly responding to easier financial conditions: In the U.S., the housing market appears to have turned a corner and auto sales have held up. In the euro area, machinery investment rebounded. But easier financial conditions have yet to support a broader economic recovery.
Central banks’ policy stimulus is here, as illustrated in our updated 2019 Investment Outlook. The Federal Reserve has delivered its second rate cut since the financial crisis – and looks set to ease policy further. The European Central Bank (ECB) materially exceeded market expectations in early September, launching a broad package with combined impact that should potentially be greater than the sum of its parts. These actions have provided support to risk assets. Yet we do not expect a repeat, and believe markets are likely pricing in too much additional Fed easing in the year ahead. We see little near-term risk of recession, thanks to easier financial conditions and still-robust U.S. consumer spending. And it’s far from certain the Fed will try to respond to the trade war fallout with meaningfully looser monetary policy. Supply chain disruptions could hit productive capacity, fostering mildly higher inflation even as growth slows. This complicates the case for further policy easing.
What does this mean for markets?
We see the monetary stimulus delivered to date operating with a lag. We are likely to see the German economy – Europe’s largest – contracting for another quarter. We still view the protectionist push as a key driver of global markets and economy. The U.S. and China appear likely to engage in trade talks again. We see some possibility of a truce, but a comprehensive trade deal as unlikely. Persistent uncertainty from protectionist policies is likely to remain a drag on corporate confidence and business spending. Robust consumer spending in the U.S. is key to our view that this long economic expansion is likely to remain intact.
We see moderate risk-taking likely rewarded–even as recent events reinforce our call for a greater focus on portfolio resilience. We prefer U.S. equities for their reasonable valuations and relatively high quality; and the min vol and quality factors for their defensive properties. We like emerging market debt for its coupon income. We are overweight euro area sovereigns: a relatively steeper yield curve brightens their appeal even at low yields. And we see government bonds as important portfolio stabilizers.
Elga Bartsch, PhD, is Head of Macro Research for the BlackRock Investment Institute. She is a regular contributor to The Blog
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