- Pragmatism to prevail in solving trade disputes. Disappointing growth in Q3 and Q4 2018 confirmed that surplus countries could suffer a lot from further deterioration of trade relations with the US. The market’s correction reminded President Trump that US companies won’t be immune in case of a global trade collapse. We see 2019 as a year of risk de-escalation in trade relations.
- Fiscal policies will play the role of a safety valve. President Trump’s turbo charged tax cut program bore fruit in terms of growth but jeopardized sustainability of public debt. On the opposite side fiscal conservativeness was not sustainable for societal reasons in Europe and for preserving growth in China. 2019 will be a year of fiscal re-balancing to the detriment of growth in the US (+2.5% in 2019 vs +2.9% in 2018) and in favor of demand in Europe (+1.6% of growth in 2019 vs +1.9% in 2018) and China (+6.3% in 2019 vs +6.6% in 2018).
- The Fed will be less assertive and alleviate pressures on global liquidity. A disorderly adjustment of the US fiscal policy will be a source of instability requiring the Fed to envisage a maximum of two hikes in 2019 in order to support impaired animal spirits. Risky assets (emerging and credit assets) will find some relief in this.
- Sector risk analysis suggests that the credit bubble is likely to start dis-inflating in an orderly manner. Over the last three quarters leading to Q4 18, sectors downgrades have outpaced upgrades allowing us to pinpoint the peak of the cycle in an early manner. Our growing concern on transportation, construction and car manufacturers re-emphasizes the cyclical nature of these new difficulties. This should adversely impact the global investment cycle in the short-term albeit alleviating pressure in the global credit market over the medium-term.
- Country risk analysis mirrors heterogeneity; in a broadly resilient picture, policy mistakes will remain the separating factor among emerging markets. The change of stance in the US monetary policy will play in favor of emerging economies. In this context, markets will continue to show their capacity to discriminate between sustainable and unsustainable models of growth.
- Alternative scenarios. In case the ongoing US – China negotiations fail, global trade could rapidly head towards a regime of lower growth. The equity market could experience a severe selloff, global credit conditions could significantly tighten. Confronted with mounting risks of recessions, major economies could be exposed to higher deficits hampering their capacity to tame social tensions and political risk. This is a scenario of a forced landing during which the multiple risks coalesce in a very adverse scenario to which we attribute a 25% probability (against 55% in our central case and 15% for a scenario where the global economy overheats in 2019 and consequently experiences a hard landing as a behind the curve Fed briskly tightens its policy). We have also identified 5 different tail risks in which things could turn out even more badly: a generalized trade war, the burst of US credit bubble with a systemic dimension, a default of the Italian debt, a freezing of China’s capital market and a stranded asset shock.