The Telegraph: If it comes to a crunch, it will be in Europe

‘I hope the people over at the Fed read today’s Wall Street Journal editorial,” tweeted Donald Trump, a week before Christmas, “before they make yet another mistake”.

The president apparently wanted to dissuade the world’s most important central bank from raising interest rates. Despite that, the Federal Reserve defied the Tweeter-in-chief, increasing its key borrowing cost a quarter of a percentage point to a range of 2.25pc-2.5pc.

Throughout 2018, Trump and Fed chairman Jerome Powell have been involved in an extraordinary rhetorical battle. There have been nine US rate rises since late-2015, as post-crisis emergency measures have been withdrawn – four since February, when Powell took the reins.

Despite appointing Powell, Trump has dismissed these latest decisions as “crazy” and “loco”. Last month, the resident declared he was “not even a little bit happy” with the actions of the newish Fed boss.

Like all leading central banks, the Fed is meant to be independent. History shows that, ahead of elections, governments can be tempted to create a feel-good boom by holding rates too low, increasing the danger of spiralling inflation and a future bust.

Keeping control of interest rates and other aspects of monetary policy at arms’ length from vote-chasing politicians has, for decades, been widely accepted as a good idea. Allowing technocrats to impose unpopular but necessary policies means that, in the long-run, everyone benefits from lower and more stable borrowing costs.

Myopic politicians push back, of course – of late, increasingly so. During 2018, over-bearing leaders in emerging markets including India, Brazil and Argentina have all exerted undue influence on theoretically independent central bankers.

President Erdogan went further, seizing de facto control of Turkey’s central bank, to sustain a boom built on speculation and too much debt.

Now Trump seems to be using such unenlightened, retrograde tactics to manage the largest and most advanced economy on earth. Over the last week, a rumour the president might try to fire Powell, combined with broader domestic and international fears to generate serious share price volatility.

After four consecutive days of losses, including the worst Christmas Eve ever, the bellwether Dow Jones Industrial Average surged a record-breaking 1,080 points last Wednesday, a dramatic 5pc bounce-back. Yet still, US markets are ending the year close around 20pc down since their most recent high – the definition of a “bear market”, a pattern repeated across the world’s major share indices, including in the UK.

Since March 2009, the low-point of the financial crisis, US stocks have enjoyed their longest run of gains in history.

Pumped up by quantitative easing, and ultra-low interest rates, Wall Street has led the world – almost tripling in value. The FTSE 100, over the same period, rose around 80pc. This year-end volatility reflects increasing fears that the party is over and, in 2019, we could see a world-wide stock market “correction”. This is a possibility, although I don’t see the US as the catalyst, whatever emerges from the president’s Twitter account.

Trump is concerned, amid signs of a US slowdown, that higher borrowing costs will not only rein in stock prices but also stall the broader domestic economy. Yet, while business investment has certainly softened in recent months, with the housing market weaker as rates have risen, the outlook remains pretty good.

The US looks set to register 3pc growth in 2018, despite slowing in the fourth quarter. That’s the quickest annual expansion since the financial crisis. Unemployment is at a 50-year low, fuelling stronger wage growth – and, for now at least, inflation remains in check, at just over 2pc.

There’s been a massive jolt of fiscal stimulus, of course, with Trump’s $1,500bn (£1,182bn) tax cutting package juicing up the economy over recent months. That will no doubt generate a bigger fiscal deficit in 2019 and beyond. And with the Democrats now controlling the House of Representatives, the current US “government shutdown” – this time over funding for Trump’s proposed border wall with Mexico – is just the start of a sustained period of congressional gridlock.

Yet the US is still the only major economy to have made significant steps towards monetary normality, with the Fed now not only steadily raising rates but also using quantitative tightening to descale its massive balance sheet. The US is no longer at full throttle, but with the Fed now set to raise rates twice in 2019, instead of three times, Trump – to the annoyance of his many detractors – could continue to enjoy an economic tailwind in 2019.

If there is to be a global share price collapse in 2019, it won’t derive from a domestic US slowdown. I’d also say the US-China trade war is likely to abate this coming year – with Trump having made his point about intellectual property theft and market access, but both sides realising they need to defuse tensions in the name of mutual economic growth.

There’s much talk of a looming emerging market crisis, with the MSCI EM index of leading stocks in such jurisdictions down 25pc during 2018. This reflects a rising dollar and concerns about servicing hard-currency debt. Yet EM economies are now far more resilient than in 1998, when we saw the last emerging market crisis.

Wealthy local investors, plus committed Western institutional backers, mean such markets are now far less prone to sudden downswings. And with the International Monetary Fund predicting a 4.7pc average 2019 expansion among EM economies, compared to 2.1pc across the West, these nations are still “where the growth is”.

For my money, when it comes to sparking a serious 2019 share price correction, the eurozone remains the most likely culprit.

Now, as in 2011, just before the last euro crisis rocked global markets, the currency bloc is lurching into a serious slowdown. Germany’s powerhouse economy shrunk over the summer, and the eurozone’s broader business sector is closing 2018 at a four-year low. French growth has stalled, its private sector contracting during December, not helped by gilet jaunes protests.

The flash-point remains Italy, of course, with Rome and Brussels locked in conflict over who actually controls the world’s ninth biggest economy. Trump’s rhetoric might be shocking. But an imploding eurozone would unleash genuine fear.

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