The winding down of the North’s summer provides a suitable time to consider not the near-term outlook, which many investors do on a daily basis, but to reflect on where we are heading down the road a bit. What will the next 18-24 months hold? Of course, we harbor no illusions of prescient vision and accept the hazards of the assignment and so should the reader.
The effect of monetary tightening and fiscal stimulus running its course, it seems reasonable to expect the end of the US business cycle. The Fed’s cycle will be completed. Allowing a modest gap between the last hike and the first cut could allow for a rate cut ahead of the November 2020 election. In some ways, President Trump’s criticism of the Fed policy now will deter claims later that that Fed easing is politically-motivated.
Evidence of late cycle behavior should be expected to accumulate. These include the 12-month moving average of non-farm payrolls and auto sales. While rising delinquency rates on credit cards and other debt-stress measures will rise, the end of the business cycle need not mark a credit crisis. In some ways, an important, even if overlooked characteristic of the economy is that after the violent disruptions of the Great Financial Crisis, the Great Moderation, characterized by relative longer and flatter business cycles remains intact.
However, around the time we expected the Federal Reserve to pause (Q2 19 or Q3 19), the European Central Bank may begin to gradually lift its deposit rate that is currently set at minus 40 bp. The expansion cycle will likely prevent a new ECB President (October 2019) from being too aggressive. Three-month EUIBOR may only turn positive in Q1 20.
Over this period, the UK will leave the EU. A risk of a disorderly exit appears to have increased but adjustments will be made, and a new equilibrium is likely to be found. The EU itself will have a new commission, parliament, and heads of several other institutions. This is a pivotal time for Europe. The reliance on the US is less assured. The UK may not be happy with the results, but its victory in securing a broader EU leaves the European project with an uncertain outlook. Many observers do not grasp the moment, though Merkel does.
