Can trade talks, US Fed clear ‘darkening skies’?
JOB cuts, lower profit forecasts, cost cutting, worries on debt in the US and elsewhere and concerns about China’s economy are putting a strain on the global economy.
It looks like this new year is beginning with not much good news, even the ongoing US-China trade negotiations are scant on details. Described as “speed dating,” the talks seem to be moving back and forth between Beijing and Washington, and from middle to higher levels.
All this time, the assurance is that it is positive while the demands from the US side are said to be “draconian,” there is uncertainty whether the two sides are still far apart on issues relating to, for example, intellectual property.
Hopefully, their so-called speed dating does not hit “speed bumps” as hasty marriages may not always end well.
It may be so far, so good but concrete results are required in a situation that can be considered urgent, where economic conditions have suddenly turned for the worse
Both parties have wasted a lot of time; when they should be finding a resolution much earlier, they were tussling with tariffs and counter tariffs and the situation deteriorated.
After an initial rally, market sentiment could not be sustained on this trade optimism for which positive results are essential in rebuilding the confidence that was broken in the months of intense trade fight.
“A resolution of trade tensions between major economies could lift sentiment and support global investment and trade,” said World Bank in its latest “Darkening Skies” report.
New US tariffs and the retaliatory response of trading partners now affect almost US$430 bil of global imports; about 2.5% of global trade is affected by tariffs that were imposed last year, said World Bank.
More than 5% of global trade would be impacted if all new tariffs under consideration are slapped, in the event present talks fail. Disorderly financial markets also dent confidence and business sentiment.
The Fed turning cautious and patient on further interest rate hikes temporarily calms sentiment In markets which have largely discounted these further increases.
However, complaints of overtightening does not only involve aggressive Fed rate hikes (four last year) but also its monthly withdrawal of liquidity, currently at US$50 bil, under its balance sheet reduction currently on autopilot.
Is that too much of a double whammy – raising rates and at the same time, sucking out stimulus liquidity, called quantitative easing (QE), it injected into markets since the 2008 financial crisis.
Amidst these tightening effects, markets are trying to size up how much “substantially smaller” will the Fed balance sheet get, and how long it would take for the balance sheet to get to a more normal level.
With no answers in sight, the uncertainty does not bode well for markets.
Following the 2008 financial crisis, the Fed had injected US$4.5 trillion into markets via bond purchases; that amount has now shrunk to about US$4 trillion as the Fed reduces its balance sheet.
With reserves dropping at a faster rate than the shedding of US Treasury and mortgage bonds, there is a possibility the Fed may slow down the pace of decline in reserves.
The Fed has shed about US$400bil of bonds but reserves have dropped to US$1.51 bil at the end of 2018, compared with a peak of US$2.7 trillion in 2014, according to a Reuters report.
“The pace of decline depends on how fast the bonds purchased under QE programmes mature and get rolled off the Fed’s balance sheet. Sometime this year, the roll-off will peak and then, fall off,” said Pong Teng Siew, the head of research of Inter Pacific Securities.
The possibility of a faster than expected tightening of global financing conditions is among the risks of disorderly financial market developments.
With markets expecting a pause in rate hikes while the Fed is still indicating perhaps two more increases, a sharper than expected rise in US borrowing costs may cause financial stress that has contagion effects.
The Fed is now patient in waiting for data to show up, but continued US growth (the payroll report showed 300,000 jobs added in December although the US government shutdown can affect the release of data for January) can send it back into rate hiking mode on an artificially strong economy.
Markets that are rallying on positive headlines are sadly missing the point that even without rate hikes, the continued rolloff in the Fed’s balance sheet, has the effect of tightening.
It is a fragile situation that is compounded by extremely beaten down valuations; the “darkening skies” are not going to turn bright anytime soon.