Patrik Schowitz

The Federal Reserve’s dovish stance might not last as long as exuberant investors expect

While markets’ optimistic response to progress on a US-China trade deal and Chinese economic stimulus seems sensible, expectations that the Fed will continue its leniency in this cycle may be overblown

Reading Time:3 minutes

Why you can trust SCMP

Traders work on the floor of the New York Stock Exchange on the last day of the trading year on December 31, 2018. The Dow finished up over 250 points on the final day of 2018. Photo: AFP

Patrik Schowitz

Published: 11:30am, 22 Mar 2019Updated: 10:27pm, 22 Mar 2019

It has been a wild ride in markets, with global equities falling by 17 per cent between early October and late December, only to regain almost all of that in 2019.

In hindsight, we can now discern the two principal drivers of those serious market moves, which should help us figure out where markets may go from here.

First, global economic activity late last year took a much bigger hit from the US-China trade war than most analysts had anticipated. This was partly due to actual tariffs introduced, but even more to the hit to business and consumer confidence from fears of further escalation. And this was not confined to just the US and China, but also the export-heavy economies in Europe and northern Asia.

The market reaction to this was predictably negative, as investors struggled to tell whether this was just a temporary slowdown or the beginning of a full-blown downturn.

Second, it occurred at the same time markets were also getting increasingly worried that the US Federal Reserve – still the world’s most important central bank – would just ignore rising economic fragility and keep raising interest rates, while also slowly reversing earlier bond purchases. The ongoing slowdown in the Chinese economy, even before any trade impact, did nothing to calm nerves.

US Federal Reserve chairman Jerome Powell speaks during a press conference in Washington on December 19 after the central bank raised short-term interest rates by a quarter of a percentage point, but signalled a slower pace of rate hikes in 2019. Photo: Xinhua

What turned things around was better news on all these fronts. As trade negotiations continued, it became a widely accepted view that both the US and China are genuinely working towards some sort of resolution that takes further tariffs off the table, even if some of the bigger structural issues remain unresolved. The economic news flow made it clear that while the damage from the trade war was – and still is – real, the global economy is not in a downward spiral.