Markets at a crossroad

Written by Bruce J. Clark

April 10, 2019

The major central banks may not be panicking, but they are most certainly beginning to sweat as the global economy continues to drag despite years of extreme policy support. Yesterday the IMF lowered its 2019 global growth forecast (again,) to 3.3%, predicting a slowdown in 70% of the world’s regions and reflecting downward revisions in Europe, Latin America, US, UK, Canada and Australia. https://bit.ly/2D12ys8

After 2018 there has been a coordinated effort to reflate markets: China opened the credit taps in January, the Bank of Japan has the pedal to the metal ( https://reut.rs/2YYQwZv ,) and the Fed is being forced to consider rate cuts, even though they’re reluctant to admit it. https://bit.ly/2UqVKi9 Today, the ECB balked at further stimulus amid signs of decelerating growth, not because they didn’t want to, but out of fear of showing their ever-weakening hand and making negative interest rate policy seem even more absurd than it already is. https://cnb.cx/2Ia5fvv.

Markets and macroeconomic fundamentals are at a crossroad. Investors want to believe that the central banks will be successful, but current policy prescriptions are exhausted, and at risk of being overwhelmed by greater structural disinflationary forces. Despite trillions spent globally since the 2008 recession, the recovery has been weaker and less-inclusive than projected. As former Pimco chief Mohamed el-Erian points out, the possibility of a deflationary “Japanification” of western economies is no longer being laughed off. https://bit.ly/2U5zzJo

The four-month old rally in stocks and commodities has been impressive but other widely watched risk benchmarks aren’t buying it. If underlying economic conditions were really improving, rates would be rising and the yield curve would be steepening. Money would be flowing into the equity sector, not out. https://bloom.bg/2X1d3mU And FX canaries-in-the-coalmine like the Canadian and Australian dollars would be rallying, neither of which is happening.

Competing market narratives can’t co-exist forever. Eventually one side will be proven right and the other wrong. As I wrote earlier in Beware the Dollar, the potential for a stronger US dollar poses a threat to the current reflation effort. Uncertainty over international trade and growth has served as a prop for the USD and where it goes from here will help answer the current conundrum. A break higher would be a sure sign that the global condition is worsening and a move to new highs in the dollar index (DXY – see below,) above 97.75 in the days ahead would raise that conviction.