The world's stock markets surged in response to the announcement that the United States and China have reached a new Phase 1 trade agreement. China has promised to buy more American products. The US will halve its September tariffs on certain Chinese goods from 15 to 7.5% and has suspended further tariffs scheduled for December 15, but it will keep in place the 25% tariffs on about half of Chinese imports that were imposed earlier. This week, the US House of Representatives is also expected to vote on a revised USMCA trade agreement between the US, Mexico and Canada. Although the short-term reaction to Phase 1 is a sense of relief, the US-Chinese trade war is not over. More complex issues related to technology, government subsidies and foreign investments remain unresolved and will persist for a long time, but the Phase 1 pact is a step in the right direction. Trade issues may well fade a bit as a future risk factor for financial markets.
Stock markets also reacted positively to Prime Minister Boris Johnson's decisive victory in the British election, which gave his Conservative (Tory) party a clear majority in Parliament. This will enable the PM to win parliamentary approval for the United Kingdom to leave the European Union on January 31, after which the two sides will have 11 months to reach a trade agreement. To put pressure on the negotiators, Johnson has said he intends to pass a new law that will prohibit an extension of the transition period (which starts when the UK has withdrawn from the EU and runs until the end of 2020). EU leaders have warned that this timetable is short and that the UK will be squeezed between trade negotiation demands from the EU and the United States. The EU wants to ensure that environmental, taxation, state subsidy, labour market and other rules guarantee an equitable UK-EU competitive situation. Meanwhile US negotiators will want to ease rules on trade in foodstuffs, which the EU opposes. The pound fell against both the euro and US dollar after Johnson's hard-line announcement.
Euro area purchasing managers' indices (PMIs) point to continued weak economic performance in the 19-country currency zone, and the problems of the manufacturing sector are far from over. After two months of upturns, December brought a slight decline for the IHS Markit manufacturing PMI, but no major slide as in September. The upturn in the euro area services PMI confirms that there is persistent domestic resilience. Aside from contrasting trends between services and manufacturing, we are seeing continued regional differences. The German economy remains troubled, while France is performing better.
Is it time to forget about recession risks?
One year ago, SEB's Chief Strategist, Johan Javeus, wrote about the slope of the American yield curve, which shows the differential between long- and short-term government bond yields. In the rare cases where long-term bond have lower yields than short-term ones, this yield curve "inversion" has signalled an approaching recession. Last spring the yield curve inverted, also leading to a lot of recession worries in financial markets. In the latest issue of SEB's Reflections, we study how the economy and markets usually perform after a yield curve inversion. Through the lens of history it is difficult to ignore last spring's signal, but meanwhile history indicates that the stock market rally may continue for another while. In our main scenario we expect growth to stabilise, enabling us to avoid a recession during the next two years.
Read more in the latest issue of Reflections (PDF)
Our Market view
Clear signs of stabilisation in macroeconomic statistics and positive news from the political scene have provided continued support to stock markets. A number of equity indices, including both the broad American S&P 500 and the narrower Swedish OMX index, have reached new highs. The US stock market has climbed during nine of the past ten weeks.
Dovish signals from central banks are providing support, although after its October rate cut the US Federal Reserve (Fed) is now signalling that it will await coming economic developments. Long-term bond yields have rebounded after this year's sharp downturn, but they remain at extremely low levels. This past autumn, macro statistics reinforced the picture of continued global deceleration, but the most recent signals are pointing upward, or at least towards a broad-based stabilisation in major economies, though of somewhat varying strength. Together with support from central banks, this means that we foresee less risk of recession over the next couple of years. This applies especially to the US, where a continued solid labour market is helping to sustain growth.
The uncertain economic situation, along with rising share prices, is stretching market valuations further, suggesting price fluctuations ahead. The lack of investment alternatives (due to extremely low interest rates and bond yields) and decreased risks related to both growth and trade problems may nevertheless provide continued support to stock markets.
This week's agenda
Almost everyone believes that Sweden's Riksbank will hike its key interest rate from -0.25% to zero on December 19.
The weekly Market Outlook newsletter will now take a Christmas break. Our next issue will appear on Wednesday, January 8. We wish you Happy Holidays!
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