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By John Lovito - January 29, 2019
The topic du jour, in investment management circles, is what will happen to the global economy in 2019. Of course, there are a number of geopolitical risks, including the continuing trade tensions between the U.S. and China. But the other big wild card: whether the U.S. Federal Reserve will continue its procession of rate hikes. The predictable pattern from 2018 is likely over. In this quarter’s outlook, I wade into the great debate—and what each potential scenario means to investors.
2019 will be interesting to see if we got a resynchronization of global growth away from what we saw in 2018, which was a year of desynchronization.
2018 was a very interesting year. And if I had to characterize it I would say it was a year or desynchronization with regard to global growth. There is the line of thinking that we may see the Fed be closer to a pause as they want to assess what these risks will mean for the global economy. It's our view that we'll get one more hike here in 2019, and we'll see a pause after that. What will really determine what happens past there is, what are the outcomes of those geopolitical risks and what happens to the U.S. economy in inflation in particular?
To some extent, it's a great debate, because it's going to the abyss. We don't really know what a potential hard exit would look like or a soft exit. Obviously, the worst-case scenario would be a hard exit where the U.K. just leaves the European Union with really no deal in place, and it's just an abrupt divorce.
I think one of our more optimistic views as we enter 2019, it goes back to what we talked about earlier with regard to the Federal Reserve hikes being closer to an end than a beginning. That actually may begin to set a bit a better tone for emerging markets in 2019. Emerging markets suffered quite a bit because we saw the higher yields, the higher dollar. But if we see the Federal Reserve beginning to pare back what they’re doing, U.S. Treasury yields on the rise, we can actually see better conditions for emerging markets. Emerging markets sold off quite a bit last year, which means they're cheap. That could be a good condition for EM.
On the flip side is we're getting a little bit concerned about the credit cycle here in the U.S. We're in the late innings of the credit cycle. We're in the late innings of this economic expansion, not that we're calling for a recession. That said is, we look where credit spreads are priced relative to historical values, they're really priced for a little more of an optimistic scenario. While we think it may be just a little bit too optimistic given where we are on the credit cycle, we could see, for instance, high yield securities, investment grade credit securities underperform a little bit in 2019.
That said is we don't think it's a major under performance, but we do think there is some there. One reason why it won't be a major under performance is going back to the question around income. There always will be that somewhat of a backstop with regard to people looking for higher yields.
As we enter 2019 here, it is really the great debate in terms of what the Federal Reserve will do going forward with the rate rise. You know, they had a very predictable pattern in 2018 where they raised rates every quarter. A month or two ago, late in the year, late in 2018, the assumption was is they would continue that pattern to 2019, particularly for the first half of the year.
However, some of the geopolitical risks that have developed the latter part of 2018 have called that into question here as we enter 2019. Those risks are some that we talked about already, Brexit, what's going to happen there, will we have a hard exit, will we have a soft exit, and what that would mean for the European economy? Then more importantly, the U.S.-China trade war, will that accelerate? Will that get even worse? Will that then have a knock-on effect on global trade in the global economy?
As we enter 2019, and particularly the first half of 2019, we're going to begin to get a lot of the answers to the questions that were posed in the latter part of 2018. What happens to the U.S.-China trade war, what happens to Brexit, and what happens to the Federal Reserve rate hikes? We think in the end we'll get some more positive outcomes than what the market's been pricing in more recently. But that said, we have to keep an eye on it because if the outcomes are less than favorable to these geopolitical risks, the impact on global growth could be to the downside in 2019. That's something we're definitely going to want to keep an eye on.
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A talk shifts from rising rates to rate cuts, Fixed Income co-CIO John Lovito explains what he thinks lies ahead for the rest of 2019.
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