Why 2019 is same, but different, to 2016

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In many ways, the start of 2019 carries echoes of the economic environment of 2016. In 2016, the US Federal Reserve paused its rate hiking cycle in the face of slowing external growth, oil prices fell sharply, global manufacturing was weak and China was stimulating its economy. At the current juncture, the Fed has turned more dovish as it factors in the global growth slowdown more prominently in its decision-making process. China has started to stimulate its economy through various monetary and fiscal tools and growth outside the US is less than robust. In 2016, the Fed's dovish leaning catalysed a rebound in risk assets, notably in emerging markets and US high yield credit. Will that narrative repeat this year, suggesting a more positive stance on risk assets?

There are still a few key differences between the 2016 and current environment that warrant a cautious approach to risk assets. Broadly speaking, there are four differences: the US economy is now in late cycle; China is focused on deleveraging; trade policy now incorporates tariffs; and global central banks have passed the point of maximum policy accommodation.

First and most importantly, the US economy is now firmly in late cycle, while in 2016 it was still in mid cycle. Three years ago, with economic data still in expansion territory, it was much easier to, for example, buy US high yield which was pricing high risks of recession through wide credit spreads. In contrast, recession risk over a 12-month horizon is now gradually rising - and while a downturn is not our base case - recession risk seems meaningful enough to warrant higher market risk premia. Moreover, in late cycle, policy rates have moved into neutral to tight territory, which means that the ability of the economy to withstand shocks is limited. As a result, markets now need to price in higher tail risks than they did previously, making it harder to buy into risk assets on weakness.  Moreover, this time around the market is having to adjust to a lower global growth environment, with US growth decelerating from above 4% in Q2 and Q3 in 2018 to a 2% rate this year. This is in sharp contrast to 2016, when US growth was at trend for much of the year and then started accelerating in the wake of the November US elections.

Another key difference between 2016 and 2019 is that it was clear then that the Chinese authorities were stimulating their economy to affect a quick rebound in growth. Today's Chinese stimulus should at best stabilise growth. Chinese authorities continue to focus on their announced deleveraging plans, and would do what is needed to stabilise growth, but they are unlikely to drive a significant re-leveraging in "old economy" sectors. China's stimulus is also, to some degree, designed to counter headwinds from trade tariffs. While growth should stabilise and may provide a boost for Chinese assets, it looks less likely that Chinese stimulus will feed back into a synchronised rebound in the global economy.

Compared with 2016, the current global trade environment is more contentious.  "America First" trade policies, in particular US tariffs directed at Chinese goods, have raised the barriers for a boost in global trade - at least to levels seen in 2016-17.  In the near term we may see a narrowly defined agreement between the US and China on existing tariffs, but US-China trade frictions are expected to persist for some time yet.. Beyond China, it remains unclear whether the Trump Administration will escalate trade tariffs on other major trading partners such as Europe. Tariffs broadly constrain the ability of the global economy to participate in strong US growth—one reason headline risks around tariffs are an important factor in risk sentiment. Indeed, tariffs have already weighed on investor risk appetite, and we believe they warrant higher risk premia in cyclically exposed assets.

Finally, we point to a less appreciated difference between 2016 and 2019: Today G4 central banks are not as willing to expand their balance sheets in the face of growth slowdowns. Europe is a key case in point. Because 2016 was an acute period of disinflation or deflation in certain regions, it provided the ECB with the impetus to accelerate its QE program. Since then, however, as the European economy has progressed, unemployment has fallen steadily and wages in Europe are now rising at a respectable pace. Normalisation in the labour market and broad-based gains in wage negotiations are giving the ECB more confidence that inflation will gradually rise to its near 2% target. In the current environment, deflation risks have receded and inflation risks have become more balanced, the ECB is much less willing to act pre-emptively in the face of slowing growth. At the same time, the Fed is actively engaged in reducing its balance sheet - a phenomenon that did not exist in 2016. As a result, the flow of global central bank liquidity is falling today. While this would normally signify economic healing, from a risk asset perspective, diminished liquidity support is not a catalyst for a sustained risk rebound.

While there are a few parallels between 2019 and 2016, it is important to acknowledge the key differences. Certainly, the combination of a late-cycle US economy, China deleveraging, trade tariffs and reduced central bank QE support warrant a more cautious approach to risk assets.

 

Thushka Maharaj is global multi-asset strategist at JPMorgan Asset Management