by Brad Tank, CIO, Fixed Income, Neuberger Berman
If there were to be a recession this year, what might the cause be?
It is the time of year for investment outlooks, and here at Neuberger Berman we are as guilty of rubbing the crystal ball as any.
We have been gazing ahead in our Fixed Income Outlook, our Asset Allocation Committee Outlook and our “10 for 2019”, and one of our key ideas is that the U.S. and global economy will avoid recession and settle into a “soft landing” this year.
But during one of our webinars, a client asked a straightforward question: “You don’t anticipate a recession, but what could happen to change that view?”
My answer comes in the form of two “known knowns” and one “known unknown.”
The Fed
My first known known—or as close as it gets in the world of investment—is that the Federal Reserve is not the threat.
That was a bold call when we made it back in December, with so much anxiety around Chairman Jerome Powell’s views, the “dot plot” and the balance sheet unwind.
We always felt that these were just the normal communication challenges a new Fed chair has to overcome—remember what I wrote back in 2017 about Janet Yellen achieving the “pitch perfect” tone after a mere three years in office?
The reversal in sentiment since the New Year owes much to the fact that the markets have come around to this view. Powell’s good friend and former fellow FOMC board member, ex-Dallas Fed President Richard Fischer, who visited Neuberger’s offices a year ago to give us his insights into Powell’s perspectives, feels that he has generally been quite consistent, and hasn’t said anything new as market sentiment switched. We would agree.
Brexit
With constitutional crises roiling the U.K. and just nine weeks to go until the Brexit deadline, you may be surprised that this is my second known known.
For all the drama last week, there is now arguably more clarity for the coming months—if politicians kicking the can down the road counts as clarity.
Portfolio manager Nik Petrovic, our Brexit watcher in London, now thinks the probabilities have swung decisively against a default no-deal Brexit. A second referendum is now a real prospect, and it will likely ask the British public to choose between staying in the European Union, accepting the negotiated Withdrawal Agreement or a hard Brexit. A lengthy extension beyond March 29 will therefore be necessary—and that is why we regard the lack of an immediate threat from Brexit as a known known.
Broken China?
Our known unknown, and, in our view, the only genuine threat of recession in 2019, is the U.S.-China trade dispute and China’s worsening slowdown. It’s an unknown because we probably won’t have clarity for some months, and in the meantime the stakes are high and the news flow will be volatile.
In the space of 24 hours last week, Asian markets rallied when they heard good news on China’s foreign investment law to protect overseas intellectual property, and U.S. markets stuttered on reports of an imminent federal indictment against Huawei. China is still smarting from the arrest of Huawei’s Meng Wanzhou in December, but not enough to prevent Vice Premier Liu He from visiting the U.S. later this month for the next round of trade talks.
Expect leaks and rumors until the negotiating deadline on March 1, and progress on goods trade to be balanced by the longer-term sticking points around intellectual property.
On the Chinese economy, in the last two weeks disappointing trade and inflation data have taken us back to the dark days of 2016. We also found out that auto sales in China dropped last year for the first time since the 1990s. During the same period, however, the government announced a CNY600 billion ($90 billion) tax cut for small businesses and the People’s Bank of China flushed CNY560 billion ($83 billion) through the financial system in a single day, the biggest such intervention on record.
We believe that China ultimately has the big stimulus guns to fight a slowdown. However, as our Shanghai-based China bonds specialist Peter Ru points out, that stimulus is unlikely to translate into an upturn evidenced by significant data such as Purchasing Managers’ Indices until April or May at the very earliest.
Unknown Unknowns
To reiterate, recession is not our central scenario for 2019—but the biggest “known” risk comes from China, and the ultimate prognosis will likely be “unknown” for another three or four months.
So much for known knowns and known unknowns, then. It follows that there must also be some unknown unknowns out there, ready to blindside us. In three weeks I’ll be meeting clients in Italy, that haven of political stability and financial prudence. I’ll report back.
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