The bond markets are signaling increasing concern over the economic outlook. For the first time since the financial crisis, the 10-year US bond yields briefly fell below 2-year US bond yields, a development seen by many as a precursor to recession and a sell signal for equity investors. Meanwhile, the yield on the 30-year US Treasury hit a record low, below 2%, suggesting investors are expecting low rates to persist for the long term. We believe that recession fears are overdone. But investors should prepare for a more sustained period of lower interest rates.
Global stocks, which hit a record high late last month, have come under renewed pressure as worries over US-China trade relations have resurfaced. Central banks around the world have been cutting rates in a bid to offset the resulting hit to confidence. We believe this will support economic growth and markets. But the backdrop of uncertainty may make significant gains difficult. As a result, we are underweight stocks pending greater clarity on the outcome of the trade dispute.
The US-China trade war has been escalating. Last week, US President Donald Trump said he would ratchet up tariffs on Chinese imports, from 25% to 30% on USD 250bn of goods, and from 10% to 15% on another USD 300bn of products. We expect China to respond. This increases the risks for both the world economy and markets. For now, we still expect the US to avoid a recession in 2020, helped by Federal Reserve easing and the strength of consumer spending. But barring a de-escalation in trade tensions, we see limited short-term upside for stocks. Instead, we prefer income-enhancing strategies.
The Federal Reserve cut interest rates by 25 basis points on 31 July, the first rate reduction since December 2008, as part of a broader global effort by central banks to insure against economic risks and revive flagging inflation expectations. We believe that Fed easing and strong consumer demand can help avert a 2020 US recession. But risks are tilted to the downside amid escalating trade tensions. Unless the US and China de-escalate, we see limited upside for stocks over the short term.
Boris Johnson, a leading advocate of Brexit in the 2016 referendum campaign, is the new British prime minister. He has said he favors leaving the EU on 31 October with or without a deal. But the new PM will continue to face a political impasse. We now see a rising chance that the UK will be compelled to ask the EU for a third delay to Brexit. This would raise the probability of a snap general election or second Brexit referendum.
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