So that sounds like a situation where the economy is close to overheating and where central banks should be standing ready to raise interest rates. Yet this is not the case and the reason for that is that the recovery is not that strong. Real GDP in the US is still only 20% higher than in 2009 when the recovery started. Compared to other recoveries this is really rather tepid; if anything, central banks are poised to ease monetary policy in the near future.
This week saw such a view confirmed from a few different sources. On Tuesday, Trump announced that he would nominate Judy Shelton to the board of the Fed. Last month she told the Washington Post she thought US interest rates should be cut “as fast as possible.” Also on Tuesday, EU leaders nominated IMF managing director Christine Lagarde for the presidency of the European Central Bank and European bond markets breathed a sigh of relief. The relief is more about who is not going to be the new ECB president as German Bundesbank chief Jens Weidman, a known hawk, was considered to be one of the frontrunners. Finally, on Wednesday, the UK 10 year government bond yield fell below the Bank of England policy rate of 0.75% after Mark Carney, the Governor of the Bank of England, acknowledged that mounting global uncertainty might prompt policy action from central banks in some jurisdictions.
Bond yields in the three main bond markets are 1.95% in the US, 0.66% in the UK and minus 0.40% in Germany. This is what is keeping stock markets elevated – the US stock market had the best June since 1955 – not an accelerating global economy. When investors have dividend yields on offer ranging from 5% in the UK to 4% in Europe and even 2% in the US, it is difficult to sell stocks when bond yields are so low and in some cases negative.
Another piece of good news this week was the fact that trump and Xi did indeed manage to negotiate a trade truce over the weekend. Markets are still not sure exactly what this means for the global economy since the US participants in the trade war are twofold. There are US companies who have legitimate concerns about a level playing field in China. If these were the only participants on the stage from the US side investors might be very upbeat by what was announced over the weekend. However, there are also the US China hawks who, as the Chinese see it, are merely using the trade war as an excuse to contain the rise of China. It appears this story will rumble on and while it does it creates uncertainty for businesses which is not a good thing for the global economy.
The Hong Kong-China relationship has the potential to be drawn into the trade war rhetoric. Anti-China statements from US members of Congress in regards to the situation in Hong Kong have the potential to destabilise the now ongoing trade talks. So there are lots of fronts on which the two countries can fight, making for a very unpredictable outcome.