Year-end economic lyric

December 27, 2018 09:00
The EU Commission’s new president will face a parliament with many more euro-skeptics. Photo: Reuters


Political changes leave their mark on the European economy as institutional uncertainty prevails. After the European elections in May, Jean-Claude Juncker hands over to Manfred Weber as new president of the EU-Commission. He faces a new EU-parliament with many more EU-skeptics. As a result, the Five Presidents plan and Macron’s proposals for a deeper Monetary Union face no chance of realization. In Germany, party leaders Angela Merkel and Horst Seehofer prepare their departure from the political scenery, handing over to Annegret Kramp-Karrenbauer and Markus Söder.

The UK:

Starting March 30, post-Brexit life begins in the UK. The agreement on a transition period of two years limits the negative economic consequences of this divorce. However, London finds it more difficult than assumed to deepen economic ties to other trading blocs. Instead of reducing excessive EU-regulation, the new Labour government struggles to use its new freedom meaningfully and actually increases the regulatory burden for the business sector.


The Italian government continues its confrontation with the EU Commission despite rising interest rates and further rating downgrades. Its determination to introduce the promised universal basic income and simultaneously reducing tax rates and the pension age increases its popularity while creating a more hostile environment towards the EU-institutions. The 5star/Lega government’s demand for further ECB bond purchases falls on deaf ears in Frankfurt, such that it needs to seek other means to secure budget financing like incentives for residents to invest in Italian government bond. At least, new Targeted Long Term Refinance Operations (TLTRO) provide a crucial “liquidity rain” for Italian banks around summer.

Global economic cycle:

The world economy is losing steam and increasingly shows late cycle dynamics. Core inflation increases with tighter labor markets. While China’s growth slows further on the back of a more cautious credit injection into the economy and trade tensions, political developments and institutional uncertainties weigh on the euro area. The US-economy, however, continues to grow above potential, still stimulated by tax cuts and higher government spending. Politically, the Democratic Party experiences tailwinds as the President’s party loses support.

Liquidity conditions:

Central banks are continuing to reduce the provision of liquidity. The US-Fed, that started reducing its balance sheet in 2017, continues at an accelerated pace, while the ECB ends it asset purchases and the Bank of Japan reduces further its treasury purchases. As a result, one of the major driving forces in recent years behind the positive market developments, the spread compression and PE-multiple expansion not only fades but contracts.

Risky assets:

Investors desperately look for assets that provide decent returns that compensate for the risk they entail. Despite positive earnings growth in all sectors this becomes increasingly difficult. Developed equity markets have a hard time, while emerging equity markets do not fare much better. Some investors find comfort in credit. On global real estate markets higher bond yields kill any fantasy for a further compression of risk premia and falling cap rates.


On the back of high money market rates and with a view that the Fed hiking cycle ends in 2019, bond yields in the US increase further towards the middle of the year before sliding down thereafter. Carry and roll-down make US-treasuries one of the best performing asset classes globally.

Trump and the Democratic Party:

US politics remain in a completely partisan way. The Democratic Party enjoys headwinds as they seek to exploit the Mueller investigation. Discussions focus on how to impeach the President. While those do not lead anywhere, they energize the Democratic supporters – especially among younger and female voters.

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Chief Economist, Head Economic Research at Bank J Safra Sarasin