Powell’s “put” and the song of the dove
A sharp dovish turn from the Federal Reserve (Fed) in January led to speculation about a “Powell put” and echoed the expectations once placed on Janet Yellen, Ben Bernanke and Alan Greenspan (i.e., that the Fed would step in if equity markets fell sharply). In December, Fed chairman Jerome Powell was singing the economy’s praises and suggesting the Fed’s balance sheet runoff was on “automatic pilot.” By January, he was highlighting slowing global growth and indicating flexibility in the effort to reduce the balance sheet. The change of course culminated in a very cautious March meeting, where Fed members conveyed their expectation for no further rate hikes in 2019.
This was particularly fascinating because the conditions used to justify the January shift were largely the same conditions faced in December. Specifically, Powell emphasized tightness in financial conditions. In fact, financial conditions had eased in early January. Similarly, while the Fed’s growth expectations were revised down in March relative to December, these minor adjustments ordinarily would not warrant such a dramatic tack.
The Fed wasn’t the only central bank to change its tune. The European Central Bank (ECB) also surprised on the dovish side at its March meeting, extending forward guidance and announcing that another round of financing to banks called targeted long-term refinancing operations, or TLTROs, would begin in the fall. Markets responded in a risk-off fashion with the euro selling off, European government bond yields falling and eurozone bank stocks dropping by nearly 5%. This was partially due to the ECB sharply marking down its growth and inflation forecasts and also the perception that the central bank was behind the curve in dealing with slowing growth.
The Bank of Canada (BOC) joined the dovish chorus in March as well, dropping its pledge to continue raising rates into a neutral range while noting that the slowdown in the global economy has been “more pronounced and widespread” than the BOC had forecast. The Canadian economy grew just 0.4 percent in the fourth quarter, providing more evidence for those arguing that the BOC was out of tune with the slowdown.
The U.S. and China are getting closer, but to what exactly?
The early December trade truce agreed to by President Trump and President Xi Jinping was extended past the original target date of March 1. However, a mid-March summit at Mar-a-Lago failed to materialize and it now looks like any potential agreement will be pushed back until at least April and possibly June, though timing remains highly fluid.
Procedural questions remain for the U.S. relative to existing tariffs, which currently affect $250 billion in goods. The U.S. may remove the tariffs while maintaining the threat to reinstitute them if China does not accomplish certain reforms, or it may seek to maintain the tariffs until the reforms are in place. While we expect an agreement in the short-to-medium term, the role of tariffs in the negotiations and ultimate deal is likely to cause continued uncertainty.
Potential features of a U.S.-China trade deal
Additional purchases of U.S. goods by China
- Goal of reducing the bilateral trade deficit
- Soybeans and natural gas are likely commodities
Ending currency manipulation
- Including language by which China agrees to stop weakening its currency to boost competitiveness
- Opening several markets to global competition
- Financial services, insurance, automobiles
Possible impediments to a deal
- China’s state subsidies to corporations
- Forced joint ventures/technology transfers
- Intellectual property protection
The European Union may be the next target for the U.S. administration’s aggressive trade renegotiation strategy. After China, the EU has the largest trade surplus with the U.S., and President Trump has made it clear he wants to focus on European autos and auto parts. Now, with the blessing of the Commerce Department, he has the leeway to impose — or more likely, threaten to impose — tariffs on this industry. While we do not expect the U.S. to enact these tariffs, the threat alone could roil markets in the coming months.
Equity earnings: Expectations take a tumble but have they fallen too far?
While equity investors have grown accustomed to +20% earnings growth over the last few quarters, this figure will likely come back to earth in the first quarter. With negative earnings growth expected in the quarter (and very slight positive earnings growth expected in quarters two and three), investors may fear a repeat of 2015–2016, when the U.S. saw negative earnings growth for six consecutive quarters.
First-quarter earnings expectations for U.S. companies have been downgraded by 6.6% since the end of 2018, a steep drop that is much larger than the average decline.