Risks and silver linings amid the global economic malaise

The IMF/World Bank meeting in Washington did not exactly begin on an optimistic note, Kristalina Georgieva, Christine Lagarde’s successor as the managing directors of the IMF, announced a cut in the Fund’s global growth forecast to 3%, the lowest since the 2008 financial crisis. This cut did not exactly surprise me. Trade/manufacturing are in a de facto recession, as the fall in Chinese, German, South Korean, Taiwanese and Singaporean exports in 2019 attests. The IMF’s global growth forecast was 3.8% in 2017 and 3.2% just six months ago. The deceleration in emerging markets has been particularly nasty, from 4.5% GDP growth in 2018 to a 3.9% now.Emerging markets are a tale of synchronized stagnation from Brazil to Mexico, Russia to India, Saudi Arabia to China. Industrial metals (Dr. Copper!) and commodities prices reflect the synchronized global economic growth slowdown, as do PMI indices, factory orders and disruptions in global supply chains.

Even an Iranian/Houthi ballistic drone attack on Saudi Arabia’s Abqaiq oil processing refinery was not sufficient to boost the price of crude oil. Black gold is a mere $58 Brent, below its level after the OPEC ministerial monitoring conference in Abu Dhabi. The IEA has cut its estimate of global petroleum demand in both 2019 and 2020. Oil and gas shares have been the worst performing sector on Wall Street and London in the past decade.

There is simply no geopolitical risk premium in crude oil, despite multiple civil wars, interstate confrontations, arms races and terrorist violence across the Middle East. The world economy is not in recession, thanks to Trump’s tax cuts, the robust US consumer (70% of the American GDP while manufacturing is a mere 11%), the best capitalized banking system on the planet but dozens of countries around the world are now caught in a deflationary big chill.

It is still premature to celebrate the “substantial phase one” (Trump’s words) of a US-China trade deal. In essence, all that has happened is that China has agreed to purchase $40 – 50 billion of US soybean and pork exports in exchange for Washington’s decision not to increase tariffs from 25% to 30% on $250 billion Chinese imports.

However, I believe the milestone to track/watch is if the US Treasury rescinds its decision to declare the Middle Kingdom “a major currency manipulator” in exchange for Beijing’s pledge not to engage in competitive devaluations. I would definitely not hold my breath on the lifting of industrial subsidies, any real reform of the PRC’s 143,000 state owned companies (almost all fiefdoms of President Xi’s clan allies in the Communist Party’s pinnacles of power) or the failure to protect the intellectual property of Western/foreign firms forced to partner with the Chinese in joint ventures. This means tensions between Washington and China on trade, technology transfers and national security (notice the absence of any rollback of the ban on PLA linked Chinese telecom equipment firm Huawei Technologies) will continue to haunt the financial markets.

This will be the case even if Presidents Trump and Xi ink a trade deal at the Apec head of state Chile summit in November. Both Trump and Xi have a compelling political rationale to seal a deal but the economic policy chasm between the Chinese and American governments are simply too vast.

The biggest silver lining I see in the current global economic climate is that the Federal Reserve, the ECB, the People’s Bank of China, the Reserve Bank of India and other prominent central banks have not wasted any time in slashing interest rates in 2019. The Powell Fed, which raised the overnight borrowing rate four times in 2018 and provoked a mini-stock market meltdown in the last quarter of 2018, has cut the Fed Funds rate by 25 basis points at the July and September FOMC conclaves. The capital markets expect the Federal Reserve to cut the Fed Funds rate to a 1.50 – 1.75% target at the October 30 FOMC – and a rate cut in December is also in the realms of possibility.

The outgoing ECB President Mario Draghi did “whatever it takes” to save the Euro, boost direct lending (LTRO) in the Eurozone economies and revive the Old World’s sluggish growth rate. His successor Christine Lagarde is a former French Finance Minister plugged in with the Reich Chancellery in Berlin. The financial markets will be euphoric if Madame Lagarde and Frau Markel can manage to persuade the hard money zealots of the Reichstag and the Bundesbank to green light a German fiscal stimulus for Europe. The Chinese central bank has even injected $100 billion into its money market by a cut in the banking system’s reserve requirement ratio (RRR).

Sterling’s meteoric ascent thrills me as I have been a sterling bull since early September at 1.20 and even called for a 1.30 cable target in several published articles in the financial press. Cable is 1.2830 as I write. I remember the House of Commons rejected three Theresa May Brexit deals and I cannot even begin to fathom the complex, tragic politics of Ulster/Eire, whose latest incarnation is Mrs. Arlene Foster’s DUP. Did not the old Scots poet say there is many a slip betwixt the cup and the lip? In foreign exchange, the meek only inherit the earth if they remember to keep prudent stop losses.

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1 Comment

  1. admin says:

    For those who feel markets are at the top, you risk missing the bus. India has one of the highest real rates since 2002 which provides room for last few rate cuts by RBI. The spread between the 10 year paper and nifty earning yields at just 60 bps, one of the lowest levels in history. This is the reason valuations of Indian equities shall remain high compared to previous years and other emerging market peers.

    The elevated PE levels or the recent IPO boom may signal revival of animal spirits in the economy or an over exuberant market. Historically, bull markets in India have never peaked with interest rates bottoming out, rather this happens mostly at the initial phase of a bull cycle.
    For those who feel markets are at the top, you risk missing the bus. India has one of the highest real rates since 2002 which provides room for last few rate cuts by RBI. The spread between the 10 year paper and nifty earning yields at just 60 bps, one of the lowest levels in history. This is the reason valuations of Indian equities shall remain high compared to previous years and other emerging market peers.

    The elevated PE levels or the recent IPO boom may signal revival of animal spirits in the economy or an over exuberant market. Historically, bull markets in India have never peaked with interest rates bottoming out, rather this happens mostly at the initial phase of a bull cycle.

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