Since we began highlighting the return of fiscal leadership as a primary driver for economic and market activity nearly two years ago, we’ve seen the return to central bank dominance, particularly by the U.S. Federal Reserve. This has significant implications for global markets.
After a decade of easy money, the 2017 Tax Cuts and Jobs Act provided incentives for investment, and in 2018, the regulatory environment had eased and additional government spending programs further boosted demand. In fact, in our 2018 Outlook: The Return of the Business Cycle, we highlighted the return of fiscal leadership as a primary driver for economic and market activity. The improved growth environment led to a tighter monetary stance from the Federal Reserve (Fed) in 2018, even as the contentious trade environment diminished business investment.
Fast forward to today, and the U.S.-China trade confrontation persists. The fiscal tailwinds of taxes, regulation, and spending have been no match for trade headwinds. The result: A return of central bank dominance, highlighted by the U.S. Federal Reserve, which lowered interest rates again last week. As shown in [Figure 1] the Fed is not alone, as the trade environment has weighed on global growth, prompting the European Central Bank (ECB), the Bank of Japan (BOJ), and the People’s Bank of China all to take accommodative actions in recent weeks amid the mountain of global negative yielding sovereign debt, which we alsodiscussed in The Curious Case of Negative Yields last week.
A FED DIVIDED
As expected, the Fed cut rates by 0.25% September 18 and made minimal changes to its statement. But disparate views on policy were notable. There were three dissenters—two members of the Fed policy committee voted to hold rates unchanged, and one wanted a larger 0.5% cut. Only 7 of 17 members expressed the view that rates should be cut again this year, introducing more uncertainty about the next cut even though bond markets still expect another one this year.
The strong characterization of the U.S. economy was also notable. In fact, the Fed slightly increased its U.S. economic growth forecast for 2019, despite weakening business fixed investment and exports. We expect one more rate cut in 2019 and for markets to continue to follow the central bank’s lead, in the absence of meaningful news on trade. That means stocks and bonds may be well supported.
MARIO DRAGHI’S SWAN SONG
At the conclusion of the ECB’s September 12 meeting, Mario Draghi, the outgoing head of the ECB, announced a dramatic series of steps that cemented his legacy, also marked by his famous 2012 “whatever it takes” quote. The ECB cut its target interest rate further into negative territory by 0.1% to -0.50% and committed to purchasing 20 billion euros ($22 billion) of Eurozone debt each month until inflation achieves the central bank’s target of just under 2% growth. The ECB, and Draghi’s successor Christine Lagarde, are now committed to policy accommodation that could potentially last years.
The ECB joins central banks around the world in cutting interest rates in response to slowing global growth caused by the U.S.-China trade conflict. Export-dependent Eurozone economies, particularly Germany, have weakened, leading to persistently low inflation on the European continent. Prospects of a no-deal Brexit at the end of October could place further pressure on output growth.
MORE STIMULUS LIKELY AHEAD FOR THE BOJ
The BOJ decided against additional policy stimulus at its meeting last week, but it did indicate it will review its assessment of its economy and inflation next month, sparking speculation that more easing measures may be forthcoming. Monetary officials have suggested they are open to the idea of further reducing interest rates into negative territory in response to weaker global growth, and they likely want to get ahead of any economic weakness resulting from a consumption tax increase slated for October.
BOJ Governor Haruhiko Kuroda has previously highlighted four strategies to push rates lower: cutting short-term rates (currently at -0.1%), lowering the target yield for the 10-year government bond (currently 0%), expanding purchases of other assets such as stocks, and further expanding the monetary base. However, monetary officials also need to maintain a delicate balance by providing an upwardly sloping yield curve and supporting positive returns for life insurers and pension funds.
MIXED REACTION TO CHINA’S CENTRAL BANK
Despite the slowing Chinese economy, the People’s Bank of China (PBOC) chose to inject 200 billion yuan (roughly $28 billion) into its banking system last week rather than lowering its policy rate, disappointing some market participants. Policymakers are struggling with trying to balance stimulating growth through accommodative policies while limiting the perception of currency manipulation amid the ongoing trade conflict.
The return to central bank dominance, particularly by the Fed, has significant implications for global markets. In this rate-cutting environment, we will continue to favor stocks over bonds, large cap stocks over small, a balance between growth and value, cyclical sectors over defensives, and emerging markets over international developed. In our view, active management strategies may struggle relative to passive approaches until fundamentals can reassert themselves.
WEEKLY MARKET PERFORMANCE REPORT
We are pleased to share our new Weekly Market Performance report with insights on major asset classes.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results.
The economic forecasts set forth in this material may not develop as predicted.
Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.
All indexes are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges.
Index performance is not indicative of the performance of any investment.
Because of its narrow focus, specialty sector investing, such as healthcare, financials, or energy, will be subject to greater volatility than investing more broadly across many sectors and companies.
All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy.
This research material has been prepared by LPL Financial LLC.
Securities and advisory services offered through LPL Financial (LPL), a registered investment advisor and broker-dealer (member FINRA/SIPC). Insurance products are offered through LPL or its licensed affiliates. To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL is not an affiliate of and makes no representation with respect to such entity.
If your advisor is located at a bank or credit union, please note that the bank/credit union is not registered as a broker-dealer or investment advisor. Registered representatives of LPL may also be employees of the bank/credit union. These products and services are being offered through LPL or its affiliates, which are separate entities from, and not affiliates of, the bank/credit union. Securities and insurance offered through LPL or its affiliates are:
Not Insured by FDIC/NCUA or Any Other Government Agency | Not Bank/Credit Union Guaranteed | Not Bank/Credit Union Deposits or Obligations | May Lose Value
Tracking # 1-895755