Will the most recent policy changes from central banks turn the tide on global growth?
Q: From trade to Brexit, there’s a lot of issues hanging over markets now. Can you update us on your macro outlook, starting with a quick review of the past, in order to put some of these events into context?
What I've emphasized in previous outlooks is that the driving factors behind this slowdown have been principally driven by policy. Beginning in 2018, the Federal Reserve tried to normalize interest rates and went too far too fast. A lot of the volatility in the fourth quarter of 2018 was associated with Fed Chair Powell's statement that he believed that the neutral rate was significantly higher than prevailing interest rates. We thought that was a major policy mistake and we still believe the federal funds rate is above our sense of where the neutral rate is.
The second major policy issue involves China. The Chinese reversed course; they'd been stimulating quite aggressively in 2015-2016 and they switched back to focusing on deleveraging. They controlled shadow bank lending, the credit impulse went negative in 2017 and started to really fall sharply in 2018. Even now M1 growth is low. Producer Price Inflation is back below zero.
And the third factor, of course, is the trade war. The trade war has fostered a lack of confidence among business, it's created disruptions in global supply chains and has generally undermined or created a lot of business uncertainty, which manifests mostly in manufacturing and trade.
Q: We’ve had other slowdowns since the 2008-2009 crisis, but those didn’t escalate into a full-blown recession. Why is there so much concern this time around?
Q: So this time around we’ve had another plunge in global yields, the Fed has retreated from last year’s hawkishness, and other related other policy changes. Isn’t that enough to reverse the current trajectory in the global economy?
And based on current data, the LEI could actually go negative as early as this month, August. And if we look at the Federal Reserve of New York's probability of recession indicator, which is derived from the yield curve, that has now reached a level which in the past has coincided with an economic recession.
Secondly, the Chinese have undertaken a lot of policy initiatives, including the combined influence on the credit impulse and property sales, which are the primary conduit through which Chinese savings make their way into the Chinese economy.
And the third factor of course which has weighed on global growth this time around has been the trade war. There's been no improvement, there's been only escalation. The most recent escalation came on August 1st with President Trump's tweet that an additional 300 billion dollars of Chinese imports would be targeted with a 10 percent tariff on September 1st. That was followed by the U.S. Treasury Department designating China as a currency manipulator a few days later. All of this has conjured up the impression of an all out trade war reminiscent of the Smoot-Hawley tarrifs, which played out in the 1930s and which many financial historians believe contributed to the Great Depression of that era.
Q: Where do things currently stand?
If we look at the price of copper, an industrial commodity which has done a pretty good job of tracking the ebb and flow of the global economy it's back to where it was in 2016.
If we look at the break even inflation rates in the United States they're breaking to new lows. If we look at the global bond market, bond yields have plunged in recent weeks. Some of that in response to President Trump's latest tweets, which have escalated the trade war but more generally the global bond market is reacting in sympathy with the global economic cycle.
If we want to expect to see stabilization of global bond yields, we need to start to look for stabilization in the global economic cycle. We're at a fork in the road – we either get enough policy stimulus to pave the way for slow but sustainable economic growth and a global soft landing or we don't. And if we don’t, we get something worse – a global economic recession.
Q: How does this affect your outlook for global markets and the economy?
So, for the moment we're on the same page. Our expectation is there's going to be a significant amount of stimulus come through the pipeline over the course of the next six to nine months; that'll be enough to achieve a soft landing. That’ what seems to be the view embedded in in asset prices as well, judging from the U.S. money market curve and the recent breakout of the price of gold.
So if we look at a number of objective indicators there's clearly an interest rate easing cycle that has started around the world. In countries like Brazil, India, Thailand, parts of Latin America, Australia, and New Zealand there have already been cuts in interest rates. The Federal Reserve has cut interest rates by 25 basis points. As I've already said we expect more to come. The European Central Bank is preparing a large package of extra stimulus. We've got the People's Bank of China as well as the Bank of Japan making public statements about new stimulus measures.
If we look at global M0 and M1 one measured in U.S. dollars, there’s clearly been an inflection.
In general, China's approach to stimulus has been successive approximation via selective measures. They still have tremendous firepower available to them if they wish to take additional steps.
[On the trade front, the latest iteration was when the White House announced that some portion of the 300 billion Chinese imports that had been designated for a 10 percent tariffs in September might be deferred until later in December, while at the same time announcing new negotiations.]
In the United States we know that the White House is very sensitive to what happens in the stock market and the economic outlook. And we know that the odds of President Trump being re-elected in the November 2020 elections would be a lot lower if the economy is in a recession or in bad shape.
Our base case is that we think enough policy stimulus is going to come through between now and early 2020 to produce a global soft-slow-but a global soft landing for the end of the year.
Credit Impulse is defined as the change in new credit issued as a percent of gross domestic product (GDP).
Shadow banking refers to financial intermediaries involved in facilitating the creation of credit across the global financial system, but whose members are not subject to regulatory oversight.
M0 and M1 are measures of the supply of money in an economy. Each country’s central bank may use its own definitions of what constitutes money for its purposes. M0 often refers to the amount of physical cash (bills, coins), while M1 includes M0 along with checking account balances. Both are also called narrow money.
The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.
The federal funds rate (fed funds rate, fed funds target rate or intended federal funds rate) is a target interest rate that is set by the FOMC for implementing U.S. monetary policies. It is the interest rate that banks with excess reserves at a U.S. Federal Reserve district bank charge other banks that need overnight loans.
Purchasing Managers Indexes (PMI) measure the manufacturing and services sectors in an economy, based on survey data collected from a representative panel of manufacturing and services firms. PMI greater than 50 indicated economic expansion; below 50, contraction.
Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance.
All investments involve risk, including possible loss of principal.
The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Legg Mason nor any of its affiliates guarantees any rate of return or the return of capital invested.
Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls.
International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.
Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.
Past performance is no guarantee of future results. Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.
The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice. Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not take into account the particular investment objectives, financial situation or needs of individual investors.
The information in this material is confidential and proprietary and may not be used other than by the intended user. Neither Legg Mason or its affiliates or any of their officer or employee of Legg Mason accepts any liability whatsoever for any loss arising from any use of this material or its contents. This material may not be reproduced, distributed or published without prior written permission from Legg Mason. Distribution of this material may be restricted in certain jurisdictions. Any persons coming into possession of this material should seek advice for details of, and observe such restrictions (if any).
This material may have been prepared by an advisor or entity affiliated with an entity mentioned below through common control and ownership by Legg Mason, Inc. Unless otherwise noted the "$" (dollar sign) represents U.S. Dollars.
This material is only for distribution in those countries and to those recipients listed.
All investors and eligible counterparties in EU and EEA countries:
In Europe (excluding UK and Switzerland), this financial promotion is issued by Legg Mason Investments (Ireland) Limited, registered office Floor 6, Building Three, Number One, Ballsbridge, 126 Pembroke Road, Ballsbridge, Dublin 4. D04 EP27, Ireland. Registered in Ireland, Company No. 271887. Authorised and regulated by the Central Bank of Ireland.
In the UK, this financial promotion is issued by Legg Mason Investments (Europe) Limited, registered office 201 Bishopsgate, London EC2M 3AB. Registered in England and Wales, Company No. 1732037. Authorized and regulated by the UK Financial Conduct Authority.
In Switzerland, this financial promotion is issued by Legg Mason Investments (Switzerland) GmbH, authorised by the Swiss Financial Market Supervisory Authority FINMA.
Investors in Switzerland: The representative in Switzerland is FIRST INDEPENDENT FUND SERVICES LTD., Klausstrasse 33, 8008 Zurich, Switzerland and the paying agent in Switzerland is NPB Neue Privat Bank AG, Limmatquai 1, 8024 Zurich, Switzerland. Copies of the Articles of Association, the Prospectus, the Key Investor Information documents and the annual and semi-annual reports of the Company may be obtained free of charge from the representative in Switzerland.
All Investors in Hong Kong and Singapore:
This material is provided by Legg Mason Asset Management Hong Kong Limited in Hong Kong and Legg Mason Asset Management Singapore Pte. Limited (Registration Number (UEN): 200007942R) in Singapore.
This material has not been reviewed by any regulatory authority in Hong Kong or Singapore.
All Investors in the People’s Republic of China (“PRC”):
This material is provided by Legg Mason Asset Management Hong Kong Limited to intended recipients in the PRC. The content of this document is only for Press or the PRC investors investing in the QDII Product offered by PRC’s commercial bank in accordance with the regulation of China Banking Regulatory Commission. Investors should read the offering document prior to any subscription. Please seek advice from PRC’s commercial banks and/or other professional advisors, if necessary. Please note that Legg Mason and its affiliates are the Managers of the offshore funds invested by QDII Products only. Legg Mason and its affiliates are not authorized by any regulatory authority to conduct business or investment activities in China.
This material has not been reviewed by any regulatory authority in the PRC.
Distributors and existing investors in Korea and Distributors in Taiwan:
This material is provided by Legg Mason Asset Management Hong Kong Limited to eligible recipients in Korea and by Legg Mason Investments (Taiwan) Limited (Registration Number: (98) Jin Guan Tou Gu Xin Zi Di 001; Address: Suite E, 55F, Taipei 101 Tower, 7, Xin Yi Road, Section 5, Taipei 110, Taiwan, R.O.C.; Tel: (886) 2-8722 1666) in Taiwan. Legg Mason Investments (Taiwan) Limited operates and manages its business independently.
This material has not been reviewed by any regulatory authority in Korea or Taiwan.
All Investors in the Americas:
This material is provided by Legg Mason Investor Services LLC, a U.S. registered Broker-Dealer, which includes Legg Mason Americas International. Legg Mason Investor Services, LLC, Member FINRA/SIPC, and all entities mentioned are subsidiaries of Legg Mason, Inc.
All Investors in Australia and New Zealand:
This document is issued by Legg Mason Asset Management Australia Limited (ABN 76 004 835 839, AFSL 204827). The information in this document is of a general nature only and is not intended to be, and is not, a complete or definitive statement of matters described in it. It has not been prepared to take into account the investment objectives, financial objectives or particular needs of any particular person.