Summer 2019 Review


The Summer of 2019 has proven to be more eventful than initially anticipated. From puzzling “mid-cycle” interest rate cuts, to escalating trade tensions, a likely no-deal Brexit, and a yield curve inversion, the Fall 2019 semester is starting on the heels of uncertainty and jitteriness.

Rate cuts

Following the sharp December downturn partly caused by their hawkish stance, the Federal Reserve shifted into neutral as it kept the federal funds rate – 2.25%-2.50%– unchanged in June. The following month, Jerome Powel, the Chair of the Federal Reserve, announced a “mid-cycle adjustment”, decreasing the Fed Funds Rate by 25bps to 2.00%-2.25% amid growing fears of a recession. The market did not respond as well with the Fed’s precarious new stance, as the U.S. economy continues to be robust.

The news of rate cuts didn’t stop in July, as Jerome Powell issued a statement claiming that the Fed “will act as appropriate to sustain the expansion” as the trade war worsens. Many took this statement to mean that the Federal Reserve would further lower rates, causing a drop in yield in the fixed income space. Though lower rates would stimulate the economy through cheaper borrowing, how much of an impact can the Fed make with benchmark rate adjustments with an already historically low rate? Is another cycle of easing in store?

Trump Trade War

The once seemingly fruitful negotiations turned sour this Summer as tariffs on Chinese goods increased to 30%, spiking volatility in the markets as companies search for alternatives from tariff-affected Chinese goods . In a recent development, President Trump increased threats on China stating that he could “declare a national emergency”. As tensions continue to increase, markets are on the decline, with stocks such as Apple and Intel underperforming due to their reliance on the Chinese markets. Now, huge speculation lies upon the prospects of an agreement between the world’s largest economies, although the current consensus remains gloomy.

G-7 / Brexit

After failing to execute on her promise for a Brexit deal, Theresa May resigned from the office of Prime Minister of the United Kingdom in June. In a vote held in late July, the Conservative Party elected Boris Johnson as May’s replacement as head of the party and Prime Minister of the United Kingdom. Johnson, the former mayor of London, was catapulted to worldwide fame (or infamy) when he became the loudest voice in the “Vote Leave” campaign during the original Brexit referendum.

More recently, at the G-7 summit, Johnson said he would be willing to take talks on a potential Brexit deal down to the wire– the October 31st deadline set in place by the European Union. Johnson stated that if no deal is reached by that date, the United Kingdom will leave the European Union without a deal . A “no-deal” Brexit could carry some seismic repercussions. Overnight, British products would have tariffs placed on them, and the Office of Budget Responsibility estimates that the British economy could contract by 2%, causing a recession for the UK . As to the likelihood of a Brexit, Johnson is cautiously optimistic that a deal can be reached by the October 31st deadline. However, British consumers are preparing for the possibility of a no deal Brexit, by stockpiling food, medicine, and even clothing, as they fear nationwide shortages and price hikes.

On the other side of Brexit stands Jeremy Corbyn and his Labour Party desiring a no-confidence vote on Johnson’s conservative party. If Corbyn has the votes, a general election will be triggered, and potentially a second Brexit referendum will take place. The situation remains uncertain.

Yield Curve Inversion

Lastly, August saw an inverted yield curve, where shorter-dated treasuries carry a higher yield than their longer-dated counterparts. An inverted yield curve, especially when defined by the difference between the 10-year Treasury note and the 3-month bill, has historically been a trustworthy signal of a recession looming in the future. An inverted yield curve is a representation of inflation expectations for the future. The NY Fed model based on the yield curve puts the risk of a recession in the next 12 months at over 30%, the highest its been since the 2008 recession. The question remains how investors reconcile low unemployment, subdued inflation data, and a robust economy, with a historically reliable warning alarm ringing.

By Paul Menestrier - Chief Investment Officer, Devon Lall and Donny Moskovits - Portfolio Management Analysts, Baruch IMG