Trading with point and figure

Dentalfloss · Dec 20, 2019

Dentalfloss · Dec 20, 2019

A few observations on 2019 and some thoughts about risk factors for 2020

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Ostwald, Marc

16:07 (2 hours ago)

to Marc

These are anything but comprehensive and exhaustive, but for what it's worth

- Trade wars / tensions
a) Very simply, these are not going to go away. There appear to be some problems in adjusting the text of the US/China 'phase one' trade deal. As previously observed, for China to meet the targets that have been outlined (rather than detailed) for US agriculture imports, would require a quantum leap in Chinese demand, and indeed in US output capacity, both of which would strain supply chains, both in the US and in Latin America, apart from appearing unrealistic. IPR issues remain very much extant, as does the Huawei problem, and the geo-strategic (military) tensions are all too obvious. The outlook for global trade volumes is therefore likely to remain quite muted.

b) Lighthizer's comments about Trump turning his attention to Europe imparts a high risk of an escalation of tensions, which would have much broader ramifications for the global economic outlook, which hardly looks robust even assuming no escalation on this front. Nevertheless Germany’s economic woes are far more domestic than international, though an escalation of tensions would inevitably tip the economy into recession.

c) UK/EU - PM Johnson has stated that 'regulatory alignment' with the EU will not be a major consideration for the UK in trade talks with the EU. While his opinions can turn a full 180 degrees at the drop of a hat, as has been witnessed on many an occasion, this does imply any trade deal with the EU will be very limited in scope, if there is any. The EU has made it clear that it is up to the UK to decide the degree of alignment, but also that the wider the divergence, the more limited will be the scope for any deal. Given that the EU has the most trade deals of any bloc or country with other countries/blocs, it will also have to ensure that whatever is agreed does not breach the terms of any of those agreements. In other words if the UK wants exceptionalism, there will be plenty of scope for disappointment. All those countries that have existing trade agreements with the EU will be watching what materializes, and outside of the US and Canada, most will not be willing to conclude any deals until a UK/EU deal has been reached (or not as the case maybe). (As an aside, Canada has the most pressing need to sign an agreement, as the UK accounts for ca. 45% of all Canadian exports to the EU).

- US election - as things stand, and notwithstanding the Trump impeachment (technically not yet in force until the House officially 'passes the baton' to the Senate), Trump still looks likely to be re-elected, unless the economy takes an unexpected dive, above all if unemployment were to start rising.

Elsewhere, Germany and Italy continue to face the risk of the current coalitions breaking down, which hardly bodes well for further progress being made on the key Eurozone issues of Banking Union and ESM reform.

- Markets & central banks - 2019 has been a stellar year for most asset classes, even if the picture has been very divergent in commodities. To be sure, 2018's Q4 'meltdown' did provide a very flattering base effect, but years in which bonds, credit and equity indices simultaneously post strong gains, even with a backdrop of lacklustre economic and earnings growth as well as heightened trade tensions, are a rarity, and unlikely to be repeated in 2020. As previously observed, the biggest bubble is still clearly in bonds and credit, and this asset class is still the most likely source of triggers for a sharper correction. But equally this also remains a lot rate/yield environment, and the FOMO and TINA temptations to buy any significant dislocations in asset prices remains deeply ingrained, as does the incessant banging of 'relative value' drums (as opposed to outright value).

Firstly, the scope for further G3 central bank easing looks limited, and were a more adverse global economic environment to materialize, there is very limited ammunition in their lockers. Indeed the ECB and BoJ will be hoping for far more strenuous efforts by politicians to implement structural reforms and deploy fiscal measures, where there is capacity. It remains to be seen what precisely will be delivered in the UK budget in February, and it will have ramifications for the BoE policy outlook, as will the direction of UK/EU trade negotiations. Sweden's experiment with escaping the strictures of negative rates will be watched closely. There is some further limited scope for lower rates in Australia and NZ, but as RBA governor Lowe has noted, the law of diminishing returns is increasingly obvious.

2019 has seen a good deal of policy easing in the EM space, but outside of Turkey, Ukraine and to a much lesser extent Mexico, the scope for further easing is increasingly limited. China has some scope to cut rates further, but is more likely to rely on reserve requirement cuts (RRR) to try and stimulate lending, and India will need to see a clear reversal of the rise in CPI, if the RBI is to cut rates again. In both cases, the issue of rising bad debts and NPLs remains a key challenge to their respective economic outlooks, and with a spike in the volume of non-financial corporate debt that will need to be refinanced in the next 3 years, (above all external USD denominated), a further rise in defaults will create additional pressures. The US energy sector, which constitutes about 1/3 of existing US High Yield bond market issuance, also faces considerable challenges, even if it appears that the distress among the middle and lower tier companies is being used as an opportunity by the oil majors to consolidate their emergent grip, as well as streamlining the shale sector.

The Fed would appear to have done enough with its myriad of overnight and term open market operations to ensure that year end funding pressures should be more than usual, rather than a re-run of September's debacle, but the underlying problems have not been solved. This will require some changes to regulations, as well as a much broader review of its money market operations, including the FX swap window for foreign central banks. These will also have to take into account some of the potential risks about the exit from LIBOR.

Also see:

Once again, may we take this opportunity to wish all readers an enjoyable festive season and a very happy new year!

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MARC OSTWALD
Global Strategist & Chief Economist

ADM Investor Services International Limited
A Subsidiary of Archer Daniels Midland Company