Friday, 26th of July 2019
““Hell is truth seen too late.”
– Thomas Hobbes
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Stock markets were up modestly this week as the FOMC meeting scheduled for 31 July approaches. The Wednesday meeting of Fed officials holds out the promise that US interest rates will be cut for the first time since 2008, a symbolic moment in this US cycle – the longest since records began. Markets are convinced that lower policy rates are imminent with investors and economists only disagreeing over whether the committee will settle on a 25bps cut (handed an 80% probability) or a more substantial 50bps cut (handed a 20% probability). Given those odds, any decision to hold off on easing policy could cause a substantial repricing across asset markets, something that Fed Chair Jerome Powell would be loath to see. We therefore expect the Fed to go ahead with a rate cut next week, probably accompanied by some moderately dovish commentary about the state of the US economy. However, we do not see much justification for a 50bps reduction in rates at this time. To be sure, the US-China trade war rumbles on and some data have softened since the start of the year. But the Fed is not in the business of pre-empting the outcome of trade negotiations in which it has no part, while the weaker data has not been materially so. In particular, the slowdown in consumer spending in Q1, which contributed to the Fed abandoning further rate hikes this year, looks increasingly like a temporary by-product of consumers having shifted consumption to prior periods in response to the Republicans’ sweeping tax cuts in 2018. The data released so far suggests that there has been a rebound in consumer spending in Q2 with the hangover after the tax windfall (and subsequent spending binge) now having largely abated. Therefore, while the market is predicting three US rate cuts in 2019, we believe there will be fewer – at least as a base case forecast. One US rate cut followed by a long pause seems more likely to us.
On the other side of the Atlantic, the data is more unambiguously grim, and there are few reasons to believe that the outlook will improve. Previously, we have spoken at length about how dependent the Eurozone is on a healthy global trade environment as well as on the success of emerging economies, and on China in particular. When the block has prospered, growth has been driven by booming export markets and buoyant demand for signature goods like German cars, French wine and Italian textiles. However, the global slowdown, the looming threat of a disorderly Brexit, and Donald Trump’s combative approach to international trade have hit Europe hard. Germany, in particular, is in the midst of the worst recession in manufacturing since 2012 when the Eurozone was in the grip of a sovereign debt crisis that threw its very survival into doubt. So far, there has been little contagion to other sectors beyond manufacturing as resilient household spending provides a cushion for composite data prints. However, the medium-term drivers of export weakness show no signs of abating. China, for example, is currently growing at the slowest pace since official records began in 1992. Looking ahead, the country faces the unenviable task of simultaneously transitioning to a new consumer-driven economic model, shedding massive excess capacity in obsolete industries, paying off a mountain of debt, and confronting the World’s preeminent superpower on multiple fronts. A US-China trade deal (should it ever be signed) will have little bearing on most of these issues. Moreover, it could spell greater tensions between the US and EU given the size of the US bilateral trade deficit and Trump’s desire to look tough through the 2020 elections. The immediate future does not look bright for Europe. Luckily, ECB Chair Mario Draghi knows this (and his successor Christine Lagarde is of a similar mind). Rates in Europe will stay on the floor for the foreseeable future – and probably longer.
The problems of the Eurozone are well known, but rather less coverage has been afforded to the crisis unfolding in one of Africa’s largest economies, Ethiopia. The assassinations of the Chief of General Staff and the Provincial Governor of the populous Amhara region during an attempted coup in June briefly held the world’s attention. However, these are merely the most high-profile casualties of a whole series of conflicts that have erupted, or deepened, since PM Abiy Ahmed came to power a year ago. Since his election, Abiy has released thousands of political prisoners, made peace with Eritrea (after 20 years of sporadic conflict) and launched sweeping political and economic reforms that have been lauded internationally. However, in the process he has significantly raised expectations and unleashed a more violent politics of ethnic grievance, as various groups agitate for greater autonomy from the Federal government (and from each other). Ethiopia is a patchwork of ethnic and tribal communities with local loyalties and enmities that run deeper than any such equivalents at the national level. Liberalisation has made it easier for these groups to communicate and organise politically, while doing little to satisfy their complex demands. As a consequence, a whole series of conflicts have broken out which have already displaced some 3m people. Many of these are fed by a media ecosystem, freed for the first time in decades, that promotes hate speech, sectarianism and baseless conspiracies. Finally, and to add insult to injury, many of those involved in the violence today including the leader of the June coup were among the prisoners whom Abiy himself released. For now, the PM is pressing ahead with the reforms. But Ethiopia could end up a failed state if liberalisation continues to be mismanaged.
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