Two months ago, U.S. equity investors cheered a new all-time high on the S&P 500. Stocks advancing to new record numbers started looking as a normal theme given the strength in the U.S. economy, low unemployment, robust earnings, and of course Trumps’s fiscal reforms. Suddenly, the euphoria shifted to uncertainty. Equity markets began to plunge, volatility spiked, major indices entered correction territory, and Oil erased one- third of its value. Some investors are linking the market’s behavior to the 2008 financial crisis and are questioning whether a new global recession is coming.
Predicting a recession is very challenging as we can never know what the trigger will be. A 10% slide from a peak doesn’t necessarily mean we’re getting close to one. We have seen similar corrections in early 2018, 2016 and mid-2015 and no recession followed. However, there is clear evidence that the global economy is slowing down, leading investors to rotate to defensive sectors, and this is well needed to bring stock valuations to realistic levels.
On Thursday investors will get to know whether the Federal Reserve is concerned about falling asset prices when they release the minutes of November’s meeting. If the minutes doesn’t show the Fed is concerned yet, markets could further gauge the Fed’s level of concern on plummeting asset prices as many voting members of the FOMC are due to speak this week including Fed Chair Jay Powell. At this stage I don’t think monetary policymakers are too worried given unemployment is near a 50-year low, and inflation close to target levels. However, chances of slowing the pace of tightening policy are increasing and this is reflected in the CME’s FedWatch Tool where investors are anticipating a 76% chance of a rate hike in December, and only one more to follow in 2019 as opposed to three hikes projected by the Federal Reserve.
While the Fed is of great importance to restoring confidence, enhanced relations between the U.S. and China may have a bigger impact on sentiment. The meeting between Presidents Donald Trump and Xi Jinping at the upcoming G-20 summit which begins on November 30 will provide guidance on where markets may be headed next. If the two sides agree to calming tensions and finding a framework to de-escalate the ongoing trade tensions, we’re likely to see a relief rally in equity markets. However, there’s a high chance of things going in the wrong direction, so expect volatility to remain high over the next few days.
Sterling traders didn’t get excited by the Brexit divorce deal getting signed over the weekend. They know very well that the real struggle is just about to begin. GBPUSD remained near its 2018 lows today, reflecting market skepticism that the deal won’t get passed through the British House of Commons. There’s a lot of bad news that is currently priced in Sterling, but more to come if the deal is voted down by parliament, so expect risk to remain skewed to the downside.
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