Global economies slow down, what next?

At the start of 2019, we highlighted that we envisage a slowdown in the global economies with the US economy precipitating this outlook. We also highlighted that the consequent risk-off sentiment would cause a ripple effect in weakening the price valuation of the USDollar. Although we still stand by the former, we have however changed our stance on a weak dollar outlook due to the highlights below:

The Federal Reserve (Fed) chairman, Jerome Powell in his recent comments mentioned that the Fed has changed its monetary policy stance to entirely data dependent with the exclusion of forward guidance – a rare 180 degree tilt from a hawkish Fed looking to hike interest rates 2-3 times in 2019 to an uber-dovish that might even look to cut interest rates should the data hint this. Some economists and analysts have argued that J. Powell have been pressured to abruptly change policy outlook – Washington have openly hinted that for the effect of its fiscal policy to be maximized, short-term interest rates need to be kept low or perhaps cut – as current local macro-conditions points that the Fed should continue with its quantitative tightening (a monetary response some claim is even too late).

A dovish Fed would ideally mean a weak USDollar – increase money supply drives price valuation lower ceteris paribus. However, there are times other variables don’t remain constant and to put that in context we would have to reference past times where cyclical slowdown were seen in global economies [see Fig 1]

Fig 1: Chart Showing the Fed Fund Rate and the DXY over a 27-Year Period

Source: Twitter- GregTheAnalyst, @Analyst_G

Recession is cyclical. Nevertheless during a global crisis not all economies are the same – some still outperform and appear stronger compared to others in the cyclical downturn. From the figure above, during the ‘dot.com bubble bust in the 2001, significant cuts by the Fed only just created a parabolic move in the USDollar as the US economy was the strongest in the cycle – the greenback would see significant capital inflow as risk-off sentiment would make the USD a plausible make-shift safe haven asset. The reverse is seen in the 2008 global financial crisis as the US economy was the weakest in the cycle. In 2018-2019 economic cycle, amongst G10 counterparts and even the Rest of the World (RoW) the US economy is seemingly the strongest. Hence, we expect a likely repetition of “2001” with a parabolic move in the DXY [see Fig 1] despite any uber-dovishness bolster from the Federal Reserve.

Several significant G10 countries have revised their growth lower: Germany and Italy are already in a technical recession. UK GDP data continuing in its course would be in a recession in 12-months according to reports. The Euro area have revised its growth lower for the year 2019. Japan is not left out of the economic slowdown matrix.

The second largest economy in the world, China is exponentially slowing down as weaker-than-expected macro data print – mainly due to an overleveraged debt-driven economy couple with trade-war driven slowness in demand – have created a ripple effect where developed and emerging markets with economies highly dependent on global trade are in a downward spiral e.g. South Korea, Australia, New Zealand to mention a few.

Macro dynamics point to a “2001-like” bust albeit a far-more intense version ceteris paribus.

For emerging economies, should our outlook hold water we expect the ‘deteriorating axe’ not miss these market spaces.

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