Financial markets have been driven largely by five factors
over the recent year. Considering these drivers of recent market behavior, I
see a significant possibility that the market is overly pessimistic about the
The five market drivers are:
- Slowing US economic growth. Growth
has been steadily slowing since the middle of 2018 as the boost from fiscal
stimulus has come out of the system. Invesco Fixed Income still believes US economic
growth is migrating back toward its potential rate of around 1.8%, but that
stabilization has not stopped the market from being concerned about the overall
slowing growth trajectory.1 Slowing US growth has been a negative
headwind for other countries and contributed to the global growth slowdown
across developed market (DM) and emerging market (EM) countries.
- Global economic policy uncertainty. Uncertainty
is high. Political trends are changing the environment for global policymakers
across the globe and, in some instances, are changing their goals and reaction
functions. Uncertainty about policymaker goals and objectives makes it more
difficult for market participants to accurately discount prospective outcomes,
and in my view, has increased volatility in markets. The Global Economic Policy
Uncertainty Index has reached all-time highs over the last year (Figure 1).
- Trade conflict. The
escalation of trade conflict has been a direct headwind for global trade
volumes, which have been steadily declining. Trade conflict has also impacted supply
chains, increased uncertainty, and weighed on investment and capital
expenditure plans. Companies’ natural reaction to trade uncertainty has been to
hold off on longer-term investment plans.
- Monetary policy interest rates. The
steady increase in US policy rates in 2018 was a headwind for markets that
culminated with the sharp market adjustments in the fourth quarter of 2018. Since
then, the US Federal Reserve (Fed) has migrated to a more dovish stance and cut
rates this year, which has been supportive of markets in 2019, offsetting some
of the market headwinds from slowing growth, in our view.
- Central bank balance sheets. Central
banks as a group aggressively expanded their balance sheets to support the
global economy from the Global Financial Crisis up to the end of 2017. Since
the end of 2017, however, the “big four” central banks, the Fed, the European
Central Bank (ECB), the Bank of Japan (BoJ), and the People’s Bank of China
(PBoC), have allowed the aggregate of their balance sheets to shrink (Figure
2). This has been led by the Fed and the PBoC but has not been offset by the
increases at the ECB and BoJ. This shrinking aggregate balance sheet has been a
headwind for the market.
news is priced into the market
The market currently appears priced for slowing global
growth and there are worries of a possible recession in the US. We believe the
US economy will grow at a pace close to potential (we expect around 2% per
year), driven by the solid labor market, wage growth, and strong consumer
demand. As an indication of the market’s pessimism on global growth, the International
Monetary Fund recently revised down its growth estimates for 2019 and 2020 for
both EM and DM economies across the globe. Without a US recession, we do not
anticipate significant further slowing in global growth.
Economic policymaker uncertainty and trade conflict is here
to stay, in our view, but should be priced into the market at this point. At
the margin, there is also the possibility of some good news on this front. The
chances of a hard Brexit are falling, and both the US and China have incentive
to look for some potential wins. The recent mini-deal announced by the US and
China is a good example.
Policymakers continue to ease. After tightening policy in
2018, global central banks have been easing in 2019. The Fed has cut rates, and
we believe it will likely continue to cut at its meeting at the end of October.
Importantly, central bank balance sheets are moving back to an expansionary
trend, starting now. The ECB has announced more quantitative easing (QE), and
the Fed balance sheet, which has been steadily shrinking, will likely pivot
sharply to expansion going forward, in our view. The Fed has announced plans to
buy $60 billion of US Treasury bills monthly for the near future to support the
functioning of the US money markets. The Fed has gone to great efforts to
characterize this as a technical adjustment, not QE, but a balance sheet
expansion is a balance sheet expansion, regardless of what you call it.
The combination of avoiding a recession in the US, pricing in bad news globally, and a pivot toward easier monetary policy may mark a change in market behavior going forward. A reversal of some of the recent market trends is possible. This could include a steepening of the US yield curve, reversal of US dollar strength, and solid performance from risky assets globally, including EM and equities. In fixed income, longer duration assets have performed strongly year-to-date.2 This may change to favor lower duration credit assets going forward.
Figure 1: Global Economic Policy Uncertainty Index
Figure 2: Big four central bank assets
1 Source: Invesco, Oct. 30, 2019.
2 Source: Bloomberg L.P., Global Aggregate Total Return Index Hedged, Jan. 1, 2019, to Oct. 30, 2019.
header image: Annie
Spratt / UnSplash
easing (QE) is a monetary policy used by
central banks to stimulate the economy when standard monetary policy has become
The Global Economic Policy Uncertainty
Index is a GDP-weighted average of national Economic Policy Uncertainty indices
for 20 countries. The national indicies track newspaper coverage of
policy-related economic uncertainty.
The International Monetary Fund is an
organization of 189 countries, and its primary purpose is to ensure the
stability of the international monetary system.
The opinions referenced above are
those of the author as of Oct. 30, 2019.
These comments should not be construed as recommendations, but as an
illustration of broader themes. Forward-looking statements are not guarantees
of future results. They involve risks, uncertainties and assumptions; there can
be no assurance that actual results will not differ materially from