BILBoard October 2019 – Central bank throat lozenges

October 17, 2019

French | German

With the change of seasons, it’s the time of year when winter coughs, colds and worse start to do the rounds. This autumn, there is a risk that a similar reality plays out in the global economy. The manufacturing sector can be considered bed-ridden at this stage, and now it is feared that other segments of the economy will soon come down with the same symptoms. Central banks are doing what they can, but without a resolution on trade, or increased appetite for fiscal stimulus, it is unlikely that they can single-handedly nurse the economy back to full health.

Indeed, the key risk hanging over the economy is that it is impossible to quarantine sectors that are suffering because of the trade war. Future returns on risk assets will largely be determined by the extent of the contagion. Key questions now include:

  • How much will the malaise in manufacturing spread to services?
  • Will weak business confidence infect employment data (and ultimately consumer spending)?
  • To what degree will macro risks bleed into the micro economy?

Amidst such uncertainty, our asset allocation, again, takes a cautious approach.

Manufacturing: more pessim-ISM

The US-Sino trade war is inflicting pain far and wide, owing to the interconnected nature of value chains around the world. Factories are bearing the brunt of the impact. A trade deal has been elusive thus far, and the potential impeachment of the US President adds more uncertainty to an already complex stew. In the absence of progress, the US ISM Manufacturing PMI dropped to 47.8 in September from 49.1, having been dragged down by New Export Orders. This is well into contractionary territory and the weakest reading since June 2009. On the other side of the Atlantic, September PMI data revealed that the recession in the German manufacturing sector went from bad to worse, with the reading plummeting to 41.7. The same figure for the broader eurozone was a pallid 45.7.

Services – catching a chill?

Though the IHS Markit Services PMI for the US remains in expansionary territory (confirmed at 50.9 in September), signs of trouble are appearing when it comes to future hiring intentions. In Germany, services, which are by far the largest contributor to output, have rapidly lost steam: the IHS Markit PMI took a sharp tumble from 54.8 in August to 51.4. For the broader eurozone, the reading dropped to 51.6 from 53.5, weighed down by falling backlogs of work and new orders.

On top of the trade-war-induced epidemic in manufacturing, the global economy also faces a series of country-specific risks: the looming Brexit deadline on 31 October, ongoing unrest in Hong Kong (which has long served as a trade, services and logistics facilitator for the Chinese economy and the broader Asian region), and geopolitical tensions in the Middle East (which affect oil prices).

Business confidence is already dented given all of the above – this has manifested itself in reduced investment and more scrupulous inventory management. For the time being, fears have not seeped into the job market, with unemployment at a 50-year low in the US (3.5%) and jobless claims are still low by historical standards. Even in the eurozone, unemployment is at the lowest level since 2008 (7.4%). With employment prospects still fine, consumer confidence is holding up – for the time being.


Though people are still spending for now, the key question is how the trade war will affect margins. It has yet to be seen if higher input costs (from tariffs) will be passed on to consumers or if a degree of margin compression will kick in. With the third quarter earnings season upon us, we held our equity weightings steady, awaiting clues from corporate guidance about the future health of the collective bottom line. There is a risk that even if the Q3 earnings season goes well, focus will quickly turn to 2020 figures which could see sharp downgrades. Until now, estimates have been relatively untouched by analysts despite the deteriorating macro picture and signs that the trade war could rage on for more months.

The brief-but-boisterous rotation in equity markets is now behind us, and defensive and growth stocks are back in favour. For the time being, we favour US equities while remaining sector neutral. In terms of style, we are giving preference to growth stocks with reasonable valuations. Our existing equity exposure benefits, and should continue to benefit, from central bank support.

Fixed income

Central banks have announced generous easing programs, but essentially this is akin to distributing throat lozenges: short-term comfort rather than a long-term cure. “Lower for longer” (and a prolonged period of negative yields) could prove to be counter-productive in the long run and it is worrying to note that QE is now being likened to antibiotics, which are losing their efficacy. But, for now at least, the markets are savouring the new monetary medicine.

The ECB will resume QE at the beginning of November but we don’t then expect any further bold action while Christine Lagarde is settling into her new role (and perhaps attempting to resolve internal bickering). A supportive ECB bodes well for European IG bonds and spreads are relatively stable. US IG is slightly less attractive, with high hedging costs and fundamentals that are tarnished by increasing gross leverage and lower interest coverage ratios.

In the US, the market implied probability for a Fed rate cut at the end of October increased from 40% to 75%, on the heels of disappointing PMI numbers. We do see one more cut before year-end, but perhaps not as early as October. Moving into 2020, the market is pricing a slow cutting cycle with the trough in December; but, with a slowing economy and low inflation expectations, the Fed could cut faster than expected. As a macro hedge, we prefer to hold Treasuries over Bunds – with the overall weight dependent on the portfolio’s risk profile.


Since our committee met last month, little has changed on the macro front. Growth is slowing but private consumption is holding up as the economy’s bedrock. The fallout in certain pockets of the global economy seems to be just about contained and central banks are supporting financial markets in the short term. We will reassess our asset allocation after more Q3 earnings results are available, giving us better grounds on which to make a diagnosis of the health of the micro economy.

ance: Indicates whether we are positive, neutral or reluctant on the asset class
Change: Indicates the change in our exposure since the previous month’s asset allocation committee

Author: Group Investment Office