A punishing December capped a year investors will be eager to forget when virtually every major asset class declined. The unpredictability that marked 2018 sets up some key conundrums facing markets in 2019.
Is the US bond market too gloomy?
The 10-year US government bond yield is the most scrutinised and significant interest rate in the world, and the market instability of 2018 shows that investors are hypersensitive to its movements.
As last year drew to a close, the $14tn market staged a vigorous rally, shoving down yields as fixed-income investors saw a US economy coming down from the stimulant-induced high.
Despite the abrupt move down in yields in November and December, which sent the 10-year yield as low as 2.72 percent, most analysts expect the yield to end 2019 at 3.44 percent. For those who regard the pessimism that gripped markets towards the end of last year as overstated, it is an augur that might just seem credible.
If that scenario plays out, it is feasible that it will further energise the dollar as more money follows the higher returns available on US assets, and deliver a setback to emerging market bonds and equities.
However, the portends of strategists for bond prices have proved too bearish in recent years. Whilst some consider that the bond market is wise to expect a much more sluggish US economy, contending that after passing four interest rate increases in 2018, the Federal Reserve may now be satisfied. For them, the more compelling challenge is whether the US yield curve inverts, which is a historically reliable barometer of a downturn that ensues when short-term bond yields rise above those for longer-dated bonds.
How will European markets cope with the demise of QE?
While the US Treasury market will produce plenty to set the orientation for other sovereign bonds, the prospects for European government debt will likewise be guided by the European Central Bank’s determination to end the multi-trillion euro bond-buying programme it opened in 2015.
As the ECB’s purchases helped depress yields, the lack of such a substantial buyer should exercise an upward push. But some remain skeptical that yields for some Eurozone countries will go up.
For a start, the ECB will go on to reinvest the profits of maturing debt it already holds. Meaning that its portfolio will persist at about the current €2.6tn level. The balanced fiscal position in some core Eurozone countries, notably Germany, affords another potential countervailing pressure to the ECB’s absence as there will be a narrow new supply of debt for investors to harvest.
For European fixed-income investors, plenty will depend on the behaviour of the Eurozone economy, which disappointed last year after an upbeat 2017. Should global trade pressures, a messy Brexit or a dislocation in relations between Italy’s populist government and Brussels scupper economists’ forecasts for a revival, then incentives for a move higher in German yields becomes even tougher to detect.
However, and on the other hand, a more sluggish Eurozone economy could still feed into a distinct dynamic for countries such as Italy, which possesses considerable volumes of fresh debt to sell after being at loggerheads with Brussels for much of last year over its spending plans. Bond investors could further be confronted by May’s European Parliament elections in which citizens have put their support behind parties pushing expansionary fiscal policies.
Will China’s renminbi extend its slide?
The performance of the Chinese renminbi remains a wild card for global investors. Those who regard the official GDP figures are inflating the strength of the economy believe Beijing will, in the end, let the renminbi fall further in 2019.
Whether Beijing and Washington can reach an accord that holds on trade will also be fundamental to the renminbi’s fate. While the wide consensus among foreign exchange strategists is that the dollar will wobble in 2019 as monetary policy moves in favour of other currencies such as the euro, many do not foresee that vulnerability to come against the renminbi.