The Federal Reserve appears to have got its monetary policy just right and may have staved off a recession before it had the chance to begin, according to Richard Batty, a fund manager in Invesco’s multi-asset team.
With the current US economic expansion the longest on record, fears of a recession have dominated market prognoses and investors’ decisions.
However, Batty pointed out cycles don’t die of old age, but typically result from policy tightening which “slays” the economic excesses of the time, such as high inflation or over-levered consumers.
He said that in this regard, the Federal Reserve may have played its cards right in acting pre-emptively.
“The US monetary stance has been one of tightening over recent years to slow tax-cut-fuelled excessive activity in the economy and to guard against inflation exceeding the Federal Reserve’s target,” he explained.
This policy appears to have worked, Batty added, as the tax support for consumption has filtered through the economy, while higher market interest rates raised borrowing costs.
“Crucially, inflation has not risen sustainably above target levels, despite a seemingly tight labour market, but US policy has caused end of cycle indicators such as the US yield curve to flatten,” said the manager.
There have been concerns that manufacturing around the world has entered a recession as a result of trade-war risks, auto emission regulation and Brexit, to name just a few headwinds. The knock-on negative effects on business confidence and investment have been noticeable, Batty said.
“Concerns across a range of emerging economies with US dollar borrowings have risen, as their currencies have weakened, reducing the ability to service debt via local currency revenues,” he continued. “Meanwhile, China’s move to prioritise a more sustainable consumer-driven economy away from an industrial-led one, has also seen growth slow, compounded by a weak credit impulse.”
However, with headwinds to growth rising, and underlying inflation falling or contained in many economies, Batty pointed out authorities have been given the green light to loosen monetary conditions: “We are now seeing the most coordinated global easing cycle ever, but one which has its limitations.”
Alternative monetary easing via restarting quantitative easing has not yet been deemed necessary, however the Invesco manager said there are a number of reasons why this has not mattered – one of the most important being that leverage has moved off consumers’ balance sheets and on to those of governments, which are much better equipped to deal with the consequences.
As the chart below shows, government debt has been the fastest-growing component of global debt since the financial crisis.
“According to the Bank of Japan, for example, the amount of outstanding Japanese bonds and bills held at the central bank is just over 43 per cent of the total outstanding at the end of Q1 2019, with most of this purchased via its QE program since 2012 – when the percentage was 10 per cent,” he added.
The manager added that as long as disruption from tariffs is limited and consumer confidence maintained, the world economy can keep growing sufficiently strongly, in aggregate, to avoid a deep recession.
However, the manager warned that it is not all plain sailing. He said that with central banks and governments attempting to loosen monetary and fiscal policy to insulate their economies from the slowdown in industrial activity, a soft-landing depends on corporate profits remaining strong and consumers maintaining their confidence.
“[But] we believe the risks of something worse are high,” Batty continued. “The investment implications could be stark. Contained market interest rates seem likely. That doesn’t stop short-lived sell-offs, but it does suggest flatter and/or lower interest rate curves.”
He added: “Further interest rate falls can cause equities to re-rate higher, if corporate profits don’t slow too aggressively.
“If trade disruption is minimised – the EU have just signed a number of free-trade deals, for example – and corporates keep their share of the economic pie, then equities can keep rising. However, the likely returns will be low, as equities are not particularly cheap.”
“As fund managers, we make investment decisions for the next two to three years to achieve our return target but have an equally important maximum risk target for our portfolios. With economic risks high, investing in the current environment won’t be easy and pin-pointing opportunities will be even more crucial to adhere to our mandates,” he finished.
Richard Batty co-manages the Invesco Global Target Returns Select fund along with David Jubb, David Millar, and Gwilym Satchell. The fund’s objective is to achieve a positive total return in all market conditions over a rolling three-year period.
Fund performance versus sector
Source: FE Analytics.
It has returned 18.62 per cent since its September 2013 launch, compared with 13.29 per cent from the IA Targeted Absolute Return sector. It has an ongoing charges figure (OCF) of 0.89 per cent.