Market correction, tech weakness, oil selloff, higher rates, China growth worries, and trade wars point to a worsening 2019 outlook. We take stock of our monetary policy calls for G3+Asia.

Taimur Baig, Nathan Chow – 23 Nov 2018 | DBS

  • Labour market and domestic demand dynamics would keep the Fed on the path of quarterly rate hikes
  • ECB and BOJ will take steps toward policy normalisation, but policy rates will remain unchanged
  • Faced with growth worries, China is heading in the opposite direction from the rest
  • India and Indonesia face sustained challenging funding conditions, justifying tight policy stance
  • For other central banks though, bias may shift to wait-and-see as opposed to pro-active tightening

Although US growth conditions have not changed, expectations have worsened for next year lately. Uncertainty about the outlook has risen as markets grapple with fears about peak growth, peak earnings, rising costs, and trade wars. Implied probability of the market’s expectations of more than 2 rate hikes next year has declined considerably.

We are not ready to throw in the towel yet though. We think that domestic demand (especially with regards to personal consumption and income) conditions in the US are likely to remain strong next year to warrant quarterly rate hikes by the Fed.We of course recognise that risks to that scenario has risen as markets have sold off, oil price has corrected sharply, and questions are being asked about the ability of the US housing sector to absorb substantially higher interest rates

The Fed would want to continue to hike, in our view, because its voting members will consider any GDP print around 2% or above sufficient to warrant continued normalisation, especially if core PCE inflation remains around 2%. We think both of those outcomes are highly likely next year. Growth will not be as high as seen this year, but that has been considered unsustainable by Fed officials in any case.

We will reconsider our call in the coming months if Fed communication changes meaningfully, markets continue to correct, and global growth slows sharply.For the time being, we will hold on to our expectation that the Fed Funds rate will hit 3.5% by the end of next year. That may well set up a 2020 slowdown or recession scenario, but if wages continue to rise, monetary policy will have to remain active, in our view.

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