We have been of the view for some time that economic growth is slowing and, in the absence of inflationary pressures, central banks continue to have free reign to loosen monetary policy. This is a familiar playbook.
In recent weeks, economic growth data have been weaker than expected and so the “lower for longer” (L4L) dynamic is starting to dominate markets again. Compounding this weaker growth environment, trade war tensions have escalated, broadening out to other countries and extending beyond trade policy objectives, such as border policy.
In response to both of these worsening dynamics, one of the big changes in markets has been the degree to which perceptions toward Fed policy have changed. The graph below illustrates how markets are increasingly discounting a cut at the Fed’s July meeting, from zero probability as recently as March, to over 80% now (calculated by using Fed Funds futures data).
Source: Bloomberg, 01/01/2019 to 18/06/2019.
Short-term negative economic momentum seems fairly set, as do the secular forcers of L4L. The trade war, however, is the wildcard. For sure, the noise building up to events like the June month end G20 meeting will increase, but trying to predict Trump’s pain threshold and the timings of a ratcheting up, or reducing, of tensions is a mug’s game. Instead, we expect the impact on economic growth of the trade war to ebb and flow, but more broadly retain our view of a L4L world.
Not only is Trump dominating the trade war, he is increasingly wading into Fed policy, pushing for lower rates. On a simplistic level, he is trying to achieve political objectives by extending the trade war and limit the economic fallout by pushing to cut rates.
In part because of this, we continue to view policy risk (both trade and monetary) as important. Maybe central bank credibility, and independence, matters less in the new world but the Fed does need to improve the clarity of its communications around its rationale over coming meetings, particularly with pressure to cut from both Trump and the market.
As for the anatomy of our portfolios, we retain a bias to quality growth in our equity and this leads us to the US, where quality growth businesses are plentiful. Elsewhere, we favour longer duration US Treasuries, we have a diversified property basket and we retain our exposure to gold, which benefits from a L4L environment, as well as from geopolitical tensions.
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Source for information: Miton as at 18/06/2019 unless otherwise stated.
The views expressed are those of the fund manager at the time of writing and are subject to change without notice. They are not necessarily the views of Miton and do not constitute investment advice.
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