January 2019

2018 ended with investors very much in risk-off mode. Markets wilted under pressure from several headwinds, including concerns about trade wars, a US recession, a global slowdown, Brexit, Italian fiscal policy, French fuel protests, leverage in the credit markets and deteriorating market liquidity.

Given the current uncertainty on markets, euro and sterling corporate treasurers will need to closely monitor economic data releases as they look to navigate central bank policy decisions over the coming 12 months.

Eurozone: Towards positive rates?

The eurozone economy has now dropped a gear, moving from above-trend to trend growth. Nevertheless, the European Central Bank (ECB) continues to guide the markets for higher rates to come. Whether the central bank actually manages to tighten and finally move rates out of negative policy remains to be seen. But with the Asset Purchase Programme recently stopped, European rates and credit markets will now have to manage without crisis support.

We are keeping a close eye on two key eurozone economic indicators for indications of the likely course that the ECB will take in 2019:

• Inflation – With wage inflation still expected to pick up in the coming months, we will be closely monitoring the situation as rising consumer prices will be central if the ECB is to justify higher rates over the next 12 months.
• Domestic demand – Improving labour market dynamics are allowing for a decline in the household savings rate and are providing investors with the confidence to embrace credit. We will be looking to see if this trend continues in 2019.

UK: Clouded by Brexit uncertainty

The UK government’s difficulty getting its Brexit deal through parliament means that the market’s fear of a no–deal scenario still cannot be discounted. In the short term, fears of a disorderly exit from the European Union will likely keep many investors quite rightly on the sidelines, or cautious on UK risk, as the uncertainty premium on UK trading is currently just too large. Sterling remains volatile, moving on Brexit-related headlines.

Keeping rates strategy shorter feels appropriate at this juncture until we have more concrete information. What we do know is with the UK bank rate at 75 basis points, the Bank of England’s Monetary Policy Committee had three cuts-worth of ammunition in a no-deal scenario (if it does actually cut at all). On a softer Brexit outcome, we believe the market will price a far steeper yield curve with a faster tightening cycle than is currently forecast.

Given the current uncertainty over the outlook for UK interest rates, we are monitoring two main areas of the UK economy for clues to the Bank of England’s thinking:

• Consumer and business confidence – Considering risks of a global slowdown fuelled by a trade war have increased and the ongoing concerns over a no-deal Brexit, investment intentions – and consumer and business confidence data – will need to be closely monitored.
• Inflation – Average weekly earnings growth rose to 3.3% in October, which is the highest level since July 2008. With unemployment remaining close to multi-year lows at 4.1%, and a reduction in net inward migration, there appears to be little slack left in the economy. This metric will certainly be closely followed by the Monetary Policy Committee as it debates interest rates.

To find out more, please visit www.jpmgloballiquidity.com

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