Market Outlook Q3 2019: Our current macro view

The solid backdrop of the world economy is likely to broaden somewhat in the second half of this year, despite the daily headlines about trade jitters and political haggling. Generous central banks will do their part to extend the economic cycle. Rising and increasingly unpredictable tail risks are the wildcards in our assessment.

Global growth is set to broaden in the second half of 2019
From a macro point of view, the global economy is currently finding its way out of the soft patch that started in late 2018 and is set to gather some momentum in the second half of 2019, according to our baseline scenario. After a confluence of special factors weighed on growth at the end of 2018, we expect economic news flow to improve in the months ahead as income growth in developed markets should lift domestic demand. We also believe that monetary and fiscal impulses from the Chinese government and the expected widening of the eurozone budget deficit will unlock further growth potential. To put it in numbers, we see annual growth rates increasing towards 2.6% in the US and 1.3% in the eurozone in the second half of 2019. 

Global growth to return to long-term trend in the months ahead Source: Goldman Sachs, Bloomberg Finance L.P., Julius Baer Economic Research

Central banks to remain accommodative
Virtually all major central banks have indicated their will not to choke the still-fragile growth. While the general direction of global policy rates was up until 2018, this has changed in 2019 so far. Indeed, the Federal Reserve (Fed) has indicated that they are ready to support financial markets with a rate cut if the escalating trade conflict threatens the US economy further. This is because a (likely) correction in financial markets in case of an escalating trade conflict would automatically result in tightening financial market conditions, very much comparable to rate hikes or a stronger currency; something definitely not in the current interest of the Fed.

Significant direct effects of the trade conflict between the US and China on economic growth will probably not trickle through until 2020 when the already on-going adjustments of supply chains will finally weigh on productivity. The detangling of highly integrated global production is a long-term process and a structural consequence of the confrontation between the two economic superpowers. However, we do not expect the next downturn of economic growth before the latter half of 2020; mainly because global central banks as well as the Chinese government will do as much as they can to cushion the impact of the trade quarrels on sentiment and growth.

Growth prospects in the Eurozone remain subdued
The European Central Bank (ECB) has started to address the growing unease in terms of growth prospects in Europe too. After its June meeting, ECB president Draghi adjusted market guidance in terms of the bank’s intention of keeping policy rates ultra-low by stating that they would be unlikely to rise until the first half of 2020. In the face of further growth headwinds and continuously weak credit activity, the central bank might be inclined to do even more, despite the healthy income growth in the eurozone. With financial repression here to stay for the time being, continuous liquidity provision and political adjustments will likely remain the only tools for politicians and central bankers to navigate the European economy around the nearby cliffs.

Inflation (expectations): not dead just yet
Inflation expectations in the eurozone have dropped significantly since the beginning of the year, casting a shadow over the outlook for growth on the old continent. While there are significant structural reasons for this drop (e.g. weak banking sector, north-south divide), we consider them unlikely to fall much further. A lot of pessimism in these expectations is owed to the trade quarrels and the increased likelihood of them turning into an outright trade war – the European economy is highly dependent on international trade, actually more than the US. An improvement in the US, as we expect it, would consequently also fuel the recovery of inflation expectations in the eurozone.

While the likely rate cut by the Fed in July might depress US inflation expectations at first and slow down any rebound attempt of 10-year Treasury yields from their currently extremely low levels, we still expect the improving economic activity to translate into higher asset prices later this year. Potential drivers of higher inflation expectations (and therefore a higher yield on 10-year Treasuries) are some transitory factors (e.g. the temporary shutdown of the US administration) as well as strong domestic income growth (currently at more than 5%) and an unemployment rate at a 49-year low.

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