4 Global themes for investors to watch

By Catherine Mann

Global growth remains robust but synchronised global growth is long gone, leaving domestic demand as the key driver for many economies and this, we know, can be extremely sensitive to vagaries in sentiment and changes in the policy environment.

There are substantial differentials emerging between a robust US, firing on all cylinders of consumption, business investment, and government; a more moderate picture for Europe with business investment more cautious relative to consumption, and China with slowing consumption and investment and with fiscal policy responding. This differentiation will filter through to emerging markets via both trade and financial linkages.

Four key themes are likely to feature prominently as investors look for signs for market direction in Q4 and into 2019:

China's growth: China's domestic growth has slowed in response to initiatives to strengthen financial institutions. Fiscal and financial policies to temper the softness in investment are in progress. We suspect that consumer demand may be the component to watch most closely to monitor the effectiveness of these policy initiatives.

Trade wars: Trade rhetoric has narrowed to the US vs China. However, extensive global value chains mean that bilateral tensions have global ramifications. China's deep integration in global value chains means that there is no such thing as a bilateral trade war. Trade accounts for 44 per cent of global GDP, with US and China total trade summing up to 10 per cent of global GDP. Given global value chains, the fact that US-China bilateral trade alone only accounts for 1 per cent of global GDP is a gross underestimate of the implications of a bilateral trade war.

Inflation: Tightening labor markets, tariffs and energy prices, and pass-through of currency depreciation in emerging markets all provide fodder for higher inflation, but incoming data remains muted. One channel of transmission that may become more relevant is how currency depreciations pass-through to inflation; the euro and yen have depreciated some 9.3 per cent and 5.5 per cent vis-à-vis the dollar since their peak in 2018.

Many emerging economies have experienced much larger depreciations, and, in the past, pass-through to inflation has been more complete. Some policymakers have taken pre-emptive action; both to stem capital outflows and to nip inflationary pass-through, even so, the consequences could be a stagflation threat: slowing growth through trade and higher inflation through currency depreciation.

Financial market volatility: Rates have moved sideways since the January sell-off, equities have performed reasonably well but, with the exception of the US have not regained January's high, probably reflecting the more heterogeneous growth environment. Only the US Dollar is really trending at the moment, although that may be a threat to risk assets in its own right.

Nonetheless, volatility is rising. Risk re-pricing (or the lack thereof) continues to generate uncertainty in asset pricing and has left investors searching for the triggers for a sell-off.

Asset markets appear sanguine about economic and political risk in general, but that may not last if the ripple effects of divergent growth, deteriorating trade conditions and possibly higher inflation become more widespread. The lack of a central bank backstop once selling pressures appear could turn higher volatility into tangibly higher risk premia.

Catherine is Citi's chief economist