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MONTHLY ANALYSIS – AUGUST 2019

The trade war between the United States and China is intensifying and the global economy slips inexorably on the edge of a possible recession that could already materialize by the end of the year. The “commercial dispute” between the two major economies has reached the next level, where the Chinese authorities might take steps which could eventually create a damage to Trump next elections. Maybe this is why Chinese newspapers keep denying Trump’s statements about a probable agreement and rather emphasize that the trade war in place will be on for long time. This would be moreover the reason why China, taking all in counterattack, recently introduced duties on US products just before the G7 meeting in France.

Whatever happens, the global economy cycle seems however projected to suffer structural damages either from the trade war or from the credit and debt cycle in the United States and China. Meanwhile, on August 21st the Labor Department of the United States, has published the labor market report, highlighting how the US economy has created 501,000 jobs less than reported by the payrolls data previously published in the last 12 months. According to this review, the payrolls monthly figures for 2018 would have been on average overestimated by 20% (from 185,000 per month to 225,000). Considering part-time jobs counted double and overestimated payrolls, the US labor market is becoming a difficult variable to be accordingly analyzed. Even the estimates on durable good are subject to significant revisions, becoming less and less reliable: in numbers for example, previous month data have been revised downwards of 40%.

Currently the international economy is suffering a slowdown, going from 3.5% in the beginning of 2018 to around 2.2% – if we consider that we are growing at 2% rate if we take for granted the fact that China is growing at 6%.

Europe is facing a possible recession already by the end of this quarter, and considering it is an economic area which is particularly exposed to the manufacturing sector, it risks a significant economic contraction. At this point markets are looking at central banks looking for help and hoping for new interventions. However, the historical period is rather critical because a further cut in rates in the United States, at the peak of credit cycle and with the system already heavily in debt, might not be the solution to boost the economy. It can be in favour of the debtor, making the cost of the debt less expensive, but new debts and additional leverage might not be able to restart the financial cycle. The problem occurring when rates approach zero is that the lender is also less and less remunerated to provide credit to the system. From my point of view, if the ECB decides to push interest rates even lower, the effect would therefore be restrictive and not expansive. The banking system would always be less incentivized to provide credit at a margin no longer remunerative, because monetary policies do not take into account the fact that below certain levels, the credit offer stops. The situation is therefore rather complicated. The FED has still a bit of margin to reduce rates but is at peak in the credit cycle and with the economy still full once again from debt excess and speculative credit. In In this case, the reduction in the cost of money does not have a stimulating effect on the economy.
In Europe the ECB “threatens” other interventions, but if those done so far have produced these results, what we can expect from new ones?

Bank of Japan is now trapped into an “eternal” QE that does not produce the expected results, simply because all the money that is printed in Japan goes into carry trades on the Dollar and US Treasuries and partially to support the Japanese public debt at zero rates (which nobody buys if not BoJ). So the Japanese economy has no tangible benefit from zero rate dynamics except a weak yen, which has strengthened over the last 12 months despite the constant QE, also because of the high degree of uncertainty that is characterizing the market.

At this point, since the ECB and BOJ do not have concrete solutions, everyone looks now at the Fed. Fiscal policies will have to be applied, sooner or later, because the monetary ones will not succeed more to boost growth and reflation the economy. We don’t know the timing and we don’t know if they will be made to prevent the recession or to get out of it, but it is certain that the historical period of low volatility on financial markets seems to have ended. History tells us that normally “policy makers” tend to act almost always late and only before the evidence of a crisis risk or a crisis already started. Thus the uncertainty scenario is reinforced and Gold has started pricing more monetary stimulus in the United States, a risk of recession and the possibility of fiscal policies that could shift higher the inflation expectations. The dollar has been trading strong till the end of the month, supported by expectations of further expansionary measures of the ECB, from the risks of hard Brexit and the weakness of the Chinese currency. However this Dollar strength does nothing but create further restrictive effects on the global credit cycle (which 80% is made by the Dollar) and tends to give negative effects on Asia and EM. The world economy would need as never before a weak dollar and expansive fiscal policies but it seems that the timing of these events is dangerously delaying due to a geopolitical and commercial context that does not work for a global coordination. The bull market on Government Bonds highlights a pre recessive context and could only be interrupted by decisive expansive fiscal policies. Only the United States could open new horizons of economic and monetary policy that so coordinated could create new spaces for growth and postpone the risk of recession. These delays in the implementation of policies to prevent a highly likely recession is likely to trigger the leverage of the system with all the consequences that we can imagine.

Source: Rosario Pisana, Chief Market Analyst at Mayfair Brooks AM

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