Opinion: Investors are digging in for an age of anxiety

Investors remain cautious despite reports of progress in trade talks between the United States and China and a much more dovish tone in recent comments from Federal Reserve policymakers.

Looming US election, mature business cycle, concerns about US-China trade concern investors

By John Kemp

LONDON, Feb 27 – Financial markets remain cautious despite reports of progress in trade talks between the United States and China and a much more dovish tone in recent comments from Federal Reserve policymakers.

Reaching a bilateral trade deal or at least postponing the implementation of punitive tariffs is probably necessary to avert the threat of a global recession or an extended slowdown, but will it be sufficient?

Most financial and real indicators show the United States and other major economies slowing sharply over the fourth quarter of last year as tariff threats, volatile financial markets and increased uncertainty took their toll.

In recent weeks, the threat of a further escalation in the U.S.-China trade conflict has fallen, with top leaders from both countries saying the talks were making good headway.

U.S. President Donald Trump has said the previous March 1 tariff deadline will be pushed back to allow more time for the negotiations (“Trump delays tariff hike on Chinese goods, citing trade talk progress”, Reuters, Feb. 24).

And the Federal Open Market Committee has indicated it will be patient and await more data before deciding its next move on interest rates.

U.S. equity indices and benchmark crude oil prices have rallied since the start of the year, reversing some of their fourth-quarter losses.

But equity and oil prices remain well below their September-October peaks and essentially unchanged from the start of 2018, illustrating the underlying caution.

Other indicators suggest investors remain wary about the economic outlook and are adopting a defensive strategy.

The U.S. Treasury yield curve has continued to flatten in a sign that investors think the risk of a recession remains elevated.

The interest rate spread between three-month and 10-year paper is down to just 18 basis points, not much wider than its current cycle-low of 14 points.

Yields on 10-year Treasury inflation-protected securities (TIPS), which strip out expected changes in the inflation rate, have fallen to just 0.75 per cent, from 1.17 per cent in early November.

Credit spreads for mid-rated U.S. corporate borrowers remain near three-year highs and far above the level in September-October, before the recent bout of financial volatility.

The spread for seasoned corporate issuers rated Baa by Moody’s over benchmark 10-year Treasury notes is just under 250 basis points, up from 180 in September.

The global economy is “fragile” and cannot take another rise in oil prices, as the U.S. president said on Twitter on Monday, accurately characterizing the sentiment across most financial markets.

Sentiment is being restrained by a mixture of cyclical and structural factors – a temporary business cycle slowdown overlaid with more enduring concerns about the outlook.

The uncertain future of U.S.-China relations, even with a trade deal, a looming presidential election in the United States, and a mature business cycle are encouraging investors to think defensively.

The bullish optimism of 2017 and early 2018, stoked by tax cuts and soaring equity valuations, has been replaced by something much more agnostic if not pessimistic.

Following a period of profound political, economic and diplomatic disruption, old certainties have been washed away but no one is certain yet about the new rules of the game.

With global growth slowing, international tensions high, mounting criticism of previously popular technology companies, and populists challenging established institutions, investors are digging in for an age of anxiety.

John Kemp is a Reuters market analyst. The views expressed are his own.

(Editing by Dale Hudson)

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