So far 2019 has demonstrated a dramatic change in sentiment for financial markets. Bond prices have rallied significantly since last autumn, with yields much lower, and this in turn has provided a favourable underpinning for share prices across the globe, including the UK.
After the turmoil of last autumn, when worries about slower growth, higher interest rates and escalating trade tensions took their toll, there is now a more stable environment. But can it last?
Factors that underpin a positive mood
There has been a sea change in expectations for monetary policy. Central banks, who had sent out hawkish signals through the tail-end of last year, have now turned dovish and pulled back on their path, and the pace, of raising interest rates.
While this has been led by the US Federal Reserve (the Fed), it is the attitudes of the European Central Bank (ECB) and the Bank of England (BOE) that warrant particular attention, as the euro area and UK economies appear particularly dependent upon loose monetary policies. Policy tightening by the ECB and BOE has contributed to an economic slowdown over the last year.
In addition, while the world economy has slowed, fears of a sharp downturn have been allayed. In part, this is due to continued steady jobs growth in western economies, plus some further recovery in wage growth, as seen in the latest UK data this week. It is also due to the response of central banks.
Other reasons to be cheerful
Although it is difficult to quantify fully the impact of each of these issues on markets, it is perhaps the favourable interest rate picture that has been the most reassuring feature for investors. The Fed gives the impression of being gradual and predictable in its actions this year, although if the jobs market continues to strengthen, there may yet be a bias to tighten again before the end of this year.
Meanwhile, the ECB and BOE need to be dovish, given their economic outlook and the balance of economic risks, with inflation slowing in the UK. Two central banks, not mentioned so far, but vitally important for the outlook, are the Bank of Japan (BOJ) and People’s Bank of China (PBOC). They, too, are in an accommodative mood, supportive of economic growth. This, too, is helping global stock markets.
Also, despite the economic weakness in Western Europe, the behaviour of markets suggests the easing of tensions in the US-China trade dispute could have a material impact. Even though it is premature to suggest a political outcome, the latest bilateral meetings suggest a toning down of tensions and an outcome that could be seen as face-saving for both sides, and favourable for global growth. A de-escalation of a potential trade war would be a big boost for economic sentiment.
But let’s be mindful of shifting sentiment – and politics
There is the need, however, for a word of warning about the present performance of markets. Sentiment can always shift again. If US wage growth accelerates and overall economic growth starts to pick up, the focus may return to whether the Fed will resume tightening. In complete contrast, there are lingering worries for some that if central banks have already had to become dovish, what policy tools can they apply if they need to do more to stimulate growth? For now, though, we would expect these issues to be put to one side, as markets wait to see how the economic data unfolds.
Meanwhile, while trade tensions have eased and bonds and share prices have rallied, there are still significant political and geopolitical issues to contend with. It has to be said, though, that these would appear to impact Britain and Europe more.
In addition to the slowdown in the euro area and the UK, there is still considerable uncertainty over Brexit, as raw politics has taken centre stage in the process, and which may not resolve itself until the end of March – or even later. Also, there is a series of elections across Europe this year. In this environment, currency markets could have a particularly important effect on portfolios, with a risk premium attached both to sterling now and the euro area in future, prompting possible currency volatility.
To reiterate a previous point I have made, the outlook will be influenced heavily by the interaction between the economic fundamentals, policy and confidence. The picture naturally varies across countries and regions, but financial markets have taken confidence that the fundamentals have benefited from an easing in tail-risks linked to trade and from a shift in monetary policy.
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