An inflection point for global trade and policy

We have reached an inflection point with regards to news on trade and global dovish monetary policy. We note an increasing discrepancy between deteriorating global data spurring monetary policy stimulus on the one hand, and news flow about trade developments on the other.

The G20 meeting in Osaka confirmed an expected thaw in relations as the US and China agreed to resume trade talks. The partial reprieve offered to Huawei was somewhat better than expected, although specifics remain scant. In general, news flow appears out of synch with the shift in tone from global central banks.

As such, we believe that the biggest risk to the global cycle is the worsening of data (especially, in the manufacturing sector) since late 2018, and expect this deterioration to drive monetary policy accommodation given low inflation. More particularly, the trade war is influencing business decisions and we are concerned about the sharp downturn in global capital expenditure. Global capex is now expected to go negative and represents a major risk to the global business cycle, in our opinion.

Long-term, the key question is if unreliable trade policy is as damaging as a frontal conflict, and the extent of impairment to global growth given emerging signs of supply chain recalibration. The global growth slowdown currently underway is expected to be disinflationary and likely to continue as the latest global PMI prints are coming in below average and are decelerating further.

Broad-based central bank easing remains our baseline scenario for the US Federal Reserve and European Central Bank (ECB). We are leaning towards a 25bps rate cut at the FOMC’s September meeting. In addition to the low inflation picture, June US Nonfarm Payrolls (NFP) figures will be critical to gauging evidence of the extent of the slowdown and determining when the Fed actually delivers. Although markets are priced for a July cut, a firm NFP could see the timing postponed temporarily.

Given continued uncertainty and damage to global capex, global central bank easing is likely to remain an important theme in coming months. Also, we do not see a link between short-term developments on the trade war front and central bank easing as downside risks to global growth are becoming firmly entrenched.

ECB ratchets up stimulus talk

The ECB has clearly ratcheted up its dovish tone as it stressed the need for additional stimulus (in line with our out-of-consensus views). ECB President Mario Draghi in a June speech in Sintra paved the way for the bank to reopen quantitative easing (QE) and cut rates as inflation consistently undershoots its target.

Such rhetoric was also echoed by other ECB members at the Helsinki conference this week.

Last but not least, the IMF chief Christine Lagarde has now been confirmed as the incoming chair of the ECB. This reinforces our expectation that QE is coming soon. Lagarde is considered to be a dove, based on her support for policy stimulus. Her appointment is likely to extend Draghi’s policy framework, in our view.

We believe the ECB could start by cutting rates 10bps to -50bps, and eventually re-start the QE program with a stronger focus on corporate bonds. Should the data fail to improve materially (our baseline view), the ECB could buy €800m-1trln worth of bonds, in our view, over a 10 month to 1 year period beginning in the autumn.

Investment implications: search for yield

We expect rates to remain low-for-longer. If some confidence on economic growth returns, the “search for yield” will become even more powerful as inflation remains below target. That said, the strong rally in risk markets means a more volatile journey from here as the situation on the trade war remains uncertain. We have turned neutral on risky assets and especially emerging markets, given developments and our lack of optimism on the global capex cycle outlook.

As the ECB prepares to re-start QE and uses signaling to powerful effect, we expect European assets to outperform on a relative basis. Quality in fixed income, such as crossover strategies, should perform well.

The prospect of central bank easing could similarly buoy equities, but we are more cautious in the medium-term, given the recession signals being sent by the bond market, which we are monitoring closely.

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