The latest signals from the Federal Reserve and European Central Bank (ECB) have reinforced market expectations that rates will stay lower for longer. The ECB maintained its ultra-easy policy, with President Mario Draghi declaring it “stands ready to adjust all instruments, as appropriate.” FOMC March minutes confirmed that officials expect rates to remain on hold for the remainder of 2019, with members noting “significant uncertainties” to the economic outlook.
Behind the caution, Fed and ECB policymakers share many of the same concerns. Brexit was singled out three times in the Fed March minutes, while Draghi cited “possibly serious effects” if Brexit were to rupture in Europe’s supply chains. Trade tariffs were top of mind; the Fed warned shifting trade policies could lead to “significant negative effects,” while Draghi found US President Trump’s frequent threats “certainly undermine general confidence” in the Eurozone. Finally, the Fed flagged the risk of “sizable spillovers from a greater-than-expected economic slowdown in Europe and China,” while the ECB noted that “risks to the euro area growth outlook remain tilted to the downside.”
While a positive outcome to each of these concerns remains our base case, we feel it is prudent for investors to await further developments before significantly adding to their risk exposure:
- Brexit: With this week's EU27 Brexit extension deal, the risk of an imminent no-deal exit has abated. However, a six-month delay does not resolve the Brexit impasse, which could now result in a general election. We can expect sluggish UK growth in the interim as uncertainty weighs on households and firms. Hedging sterling downside risks should remain attractive around upcoming Brexit deadlines.
- Trade tariffs: Our base case is for a partial resolution to the US–China trade dispute. The US has also recently threatened to impose additional tariffs on USD 11bn of EU exports. This follow a WTO ruling in favor of the US on EU financial support for Airbus. We believe this ruling may make it harder for the EU to justify retaliation, and that the risks of escalation are relatively limited. That said, risks remain in both sets of trade talks and we prefer not to take a successful outcome for granted yet.
- Slowing growth: We expect a moderate recovery in global growth in the second half of 2019, especially if trade uncertainties are resolved and companies increase capital spending. US growth is only decelerating to a trend rate of 2%–2.5%, rather than entering a recession. And China's government stimulus is helping to avert a sharp slowdown. However, the growth in the Eurozone remains fragile and we would like to see further confirmation that growth is stabilizing.
So against this uncertain backdrop we recommend only a moderately risk-on stance. Investors can ensure their portfolios are in good shape in case risk scenarios materialize through diversification, hedging downside risk, and tapping into investment strategies like sustainable investing.