FROM THE EDITOR

Hitting the Brakes

A new year sometimes begins with a bout of acidity and a splitting head, the aftermath of gastronomically motivated indulgences frequently spread over a week. Financial markets too started the year on a sour note due to global uncertainties in monetary and trade policies. They were in fact skittish for the greater part of the last 6 months, on the belief that the global growth cycle will begin to taper during the course of 2019. As some would argue, it’s about time. The free-money policy of the world’s major central banks that created about USD 11 trillion through the issue of bonds cannot be sustained forever. The United States Federal Reserve began to harden rates a year ago and continues to do at an ill-opportune time when the growth cycle is displaying signs of a taper. In Europe, the European Central Bank, after winding down its bond buying from Euro 30 billion a month to Euro 15 billion from October to December 2018, has ceased purchases since January 2019.

Financial markets have been skittish for the greater part of 2018 on the belief that the global growth cycle will begin to taper during 2019.

In America, the market turmoil is based on a premise that the effect of the Trump administration’s fiscal stimulus package, that provided a jab to investment and output, will fade. Markets suspect that growth in earnings by US corporations would shrink as a result of softening demand. As it happens, 2018 has been a rotten year with US equities tumbling by about 15%. The fact that the American government is in a shut down, because of disagreements between Congress and the White House, would have added to a sense of dread. Whilst officially 800,000 government employees do not get paid, the fact is millions more are affected especially small business enterprises, government contractors, etc.

Growth in Europe is fragile and will plausibly remain so with a no-deal Brexit looming, together with frailties creeping up in the German economy. China’s economy too, appears to have hit the dampeners with falling demand and shrinking exports.

Equities across markets in Europe and Asia have largely fallen in sync, wiping out billions of dollars in wealth. Growth in Europe is fragile and will plausibly remain so with a no-deal Brexit looming, together with frailties creeping up in the German economy. China’s economy too, appears to have hit the dampeners with falling demand and shrinking exports. Apple’s warning to investors of a slowdown in the sales of its phones and computers in China, together with softening consumer appetites in other emerging markets, are indicative of a wider worrying trend. Developments in China have been rattling markets ever since the trade war with America first began. China’s exports to the US fell by 3.5% this year. Exports to Europe have been weak as well, a consequence of shrinking consumer demand. Coupled with this, domestic demand in China has been sliding rapidly.

Rising yield spreads and a flat yield curve indicate the market’s conviction that America’s growth engine will hit the brakes and its economy will slip into recession.

The fact that stocks have lost their sheen resulted in a drop in the yields on ten-year treasury bonds, as investors dump equities in favour of secure government debt. More significantly the yield spread, which accounts for the difference between the interest rate paid on government bonds and unrated corporate debt, has jumped. This is a reflection of rising risk in corporate debt. Finally, the yield curve, which denotes the difference between short duration and long dated government debt, is almost flat. All of these suggest that markets are now convinced that America’s growth engine will hit the brakes, probably during the course of this year and its economy will slip into recession.

These developments will impact India and the first casualty would be falling exports. These have, in any event, been lacklustre over the past two years. With elections round the corner, the political uncertainties that come with such things have left domestic equity and foreign exchange markets fretting. Falling investor confidence and the consequent outward rush of hot money have manifested themselves in a 10% drop in the Sensex. A slowdown in the investment and consumption cycle is therefore a logical expectation. This is already happening.

Adit Jain, Editor

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