Moderation could be a good thing

It is difficult to discern what is on the mind of the markets amid wide intraday swings over the past month. A series of worries have accumulated that threatens what is becoming one of the longest and strongest bull markets in history. There is no shortage of possible candidates ranging from trade disputes, budget wars, growth slowdown, or Fed missteps. You can pick any one or combination of these, creating uncertainty, which markets dislike.

Many commentators see the biggest risk coming from the ongoing trade dispute between the U.S. and China. This has global consequences as this is between the two largest economies. The impact has been relatively modest for the U.S., although some sectors, noticeably agriculture, have borne the brunt. There was some promise of resolution with the December declaration of a 90-day delay in tariff escalation, but March is just around the corner. Some recent reports of easing tariffs by the U.S. or increasing imports by China provide some glimmer of progress. This conflict comes at an economically delicate time for China, which has been decelerating for some time, manufacturing is slowing, and consumers are pulling back. There are also concerns about the stability of its financial system that has twice the amount of debt as 10 years ago. A Chinese hard landing would be challenging for global markets, but progress or resolution of trade issues would be a definite positive.

Many indicators have pointed to a slowing of global growth. This reflects an easing of the pace of growth rather than a downturn. The fiscal stimulus from U.S. tax reform is past its peak and many were concerned that the pace of second and third quarter 2018 could not be sustained without triggering a troublesome increase in inflation. Some of this was to be expected as this stimulus wore off. But there also indicators of growth tapering in Europe and China. These may reflect a tapering off of robust economic activity in 2017 and early 2018, and returning to normalcy.

Recent comments from members of the Federal Reserve Open Market Committee have calmed concerns of a misstep by this central bank by increasing short-term interest rates too sharply and cutting off the expansion. The increase in fed funds in December, much criticized as unnecessary, and hawkish comments have been walked back. Recent data for consumer price and producer price indices shows subdued inflationary pressures in the U.S. The FOMC has backed off its projections for rate increases to two for 2019, but many market observers opine the actual number of increases will be less than two. But an error by FOMC and its actions could derail the expansion or further slow global growth. Some of the same worries around FOMC actions are also held concerning developed market’s central banks as they initiate monetary policy normalization. The Fed is ahead of other central banks with increasing rates and scaling back its balance sheet, but this process may prove difficult to execute without some mistakes.

As mentioned above, recent reports point to inflation being contained and likely to remain around 2 percent. However, an escalation of tariffs or wages could alter this outlook. Crude oil and gasoline prices had been moving lower over the past quarter, before a recent uptick. Should oil move higher, inflation could also accelerate. There is substantial pressure to increase oil prices, most notably from OPEC members. Oil revenues are a necessary component for these producers to balance their budgets and provide goods and services to their populations.

A final area of concern to this list revolves around political developments in Europe. Brexit is due to occur in March, absent a second British referendum or an agreed-upon delay in the U.K. exit from the European Union. A recent spat over the Italian budget meeting guidelines appears to have calmed down, but the tensions between EU member states over budgets and their respective stages of recovery and growth, could reignite at any time.

It is not all doom and gloom. The tapering of global growth, particularly in the U.S., could have the effect of prolonging the expansion. Growth rates from early 2018 were likely unsustainable, triggering inflation, financial excesses or imbalances, and corrective FOMC actions. That combination could have triggered a sharper slowdown or a recession. Moderation of growth may permit the economy to continue to expand for some time to come.

David Helscher is a senior vice president and trust officer with Clinton National Bank.