Key points from AIM’s December 2018 market commentary
The narrative around slowing growth domestically and abroad weighed heavily on risk assets in November.
Volatility in equity markets remained elevated during most of November as the CBOE VIX Index was above 20 for most of the month. The above-average levels of volatility continue to be driven by investor uncertainty around slowing growth. Until we see further clarity on trade issues with China and the rate path from the Fed, we expect volatile conditions in risk assets to continue.
A dovish sentiment around Fed rate hikes has emerged as financial conditions tightened.
For most of the month investors continued to struggle with uncertainties around U.S. and China trade, Fed rate hikes, and slowing corporate profitability. However, recent Fed-speak has toned down the hawkish language around Fed hikes as global growth has shown signs of slowing and financial conditions have begun to tighten. Specifically, newly appointed Fed Vice Chairman Richard Clarida indicated the Fed “needs to be especially data dependent” as they adjust monetary policy. In addition, Fed Chairman Powell has certainly shifted the tone as his message in early October indicated, “The Fed Fund’s rate is a long way from neutral,” where this month’s message to the markets was “Fed Funds remain just below the broad range of estimates of the level that would be neutral for the economy.” The market has clearly acknowledged the shift in sentiment, but there still is considerable uncertainty around how many more rate hikes there will be next year. As a result, the market participants have meaningfully reduced rate hike expectations for 2019 from three to less than one.
For the first time since the financial crisis, both the 2-year U.S. Treasury and the 3-year U.S. Treasury are yielding more than the 5-year Treasury.
After reaching the highest level since 2011 at just under 3.25%, the 10-year Treasury has swiftly retreated almost 40 basis points as fears of slowing growth created a risk-off environment. In addition, market expectations for future rate hikes have declined significantly to less than one hike priced in for next year. Also, for the first time since the recession both the 2-year U.S. Treasury and the 3-year U.S. Treasury are yielding more than the 5-year Treasury. While this is not an indicator of an immediate recession, it does signal that the U.S. economy is in the later stage of the business cycle. As we look forward into 2019, we expect the slowdown in growth to be less pronounced, allowing the Fed to orchestrate a softer landing for the economy than in previous cycles.
Against the backdrop of geopolitical risks, we would expect risky assets to continue to be challenged, but recognize the potential for opportunities.
Overall, the month of November was a wild ride with risk assets repricing and volatility remaining elevated, but as we project forward into 2019 we expect late-cycle themes to continue to emerge. Growth is likely to slow and the Fed will be focused on a softer landing for the U.S. economy. Against the uncertain backdrop of geopolitical risks we expect risky assets to continue to be challenged, but recognize the potential for opportunities.