After over thirty years in and around financial markets, I feel that I have seen most things. I am certainly no stranger to volatility, having spent nearly twenty of those years in interbank forex dealing rooms around the world. Even so, this year feels unusual.
The two bouts of chaos in the stock market, the first at the end of January and this one that started at the beginning of October, have been notable for two reasons. They have been long, with no sustained rapid bounce to offset the sharp drop, and they have essentially been about nothing.
More accurately, I guess, they have been about fear.
On neither occasion has there been any real numerical data to suggest problems in the U.S. economy; rather there has been a sense that things could go wrong before too long. As we end a year where that has been the focus, it is worth considering whether those things are likely to happen next year, or whether they will remain in the distance as objects of worry.
There are three main causes of concern, two of which are directly connected to prospects in the U.S. and one is a little more tangential.
The two direct worries have, naturally enough, received the most publicity, but they are less likely to cause real problems next year than the third. Those two are the Fed’s interest rate hikes and the potential damage done to the U.S. economy by a trade war. I put them together not just because of their direct influence on the economy but also because while both have the potential for massive disruption, both are also avoidable.
The Fed has even made that clear in their public pronouncements, having said many times that they are monitoring data and prepared to change at least the pace of hikes if those data indicate problems. So far, there has been no such indication. It may have slipped your mind with all the doom and gloom over the last couple of months, but the U.S. currently has just about record unemployment and decent GDP growth. Little wonder then that corporate profits, the ultimate driver of stock prices, are also at record highs.
In those circumstances, gradual rate increases by the Fed are not going to do much, if any, damage. They can, however, do a lot of good by smoothing out the economy’s tendency toward “boom and bust.” They can also ensure that any future slowdown can be countered by cutting rates again, without resort to more drastic measures.
Most importantly, the pace, and even the direction of rate changes, can be altered at any time should conditions indicate it is warranted. The adverse effects of rate hikes are therefore predictable, identifiable, and avoidable. The chances of mistakes and mismanagement should not be ignored, but they don’t merit the panic that we have seen twice this year.
That avoidability is also evident in the dangers of tariffs and trade war. They are a policy issue, and that policy can be changed just as quickly as it was instituted. In fact, the political dynamic as we enter 2019 make a change more likely than not.
Donald Trump went a long way towards creating this problem, and not just by pursuing protectionism. He has also spent the last two years pointing to the market as a measure of his success. That is a temptation that politicians generally avoid, and for good reason. No market moves in a straight line forever, and if you pretend that market gains are your doing, you can’t complain when others pretend that the drops are your fault too.
For a man under threat of impeachment or indictment on criminal charges, this is about more than his image or embarrassment: It is about survival. The President may pronounce himself a “Tariff Man” on Twitter, but if Republicans who are more economically conventional, such as Mnuchin and Kudlow, can convince him that the market will respond better to a bad deal than no deal, he will become “Free Market Man” overnight.
Both rising interest rates and protectionism are dangerous then, but both are policies that can be reversed.
The third thing on my list of dangers, Brexit, is another thing altogether. It is not a policy enacted by a bureaucrat or politician that can easily be reversed by the same. The fact that it was decided by a referendum makes it a direct instruction to British politicians from the electorate. As Theresa May has found out though, leaving the E.U. is much easier said than done.
To be fair to my fellow countrymen, most experienced and thoughtful politicians knew that would be the case. Leaving the E.U. sounds easy enough and obviously even sounded like a good idea to some people. What those politicians knew though, was that the E.U. would do their best to not make it easy.
There will be a price to pay for leaving; the U.K cannot give up the responsibilities of membership of the union and retain the benefits. In practical terms that means a serious dislocation of a massive trading relationship, and after May abandoned the most recent attempt at a deal, that is starting to look unavoidable.
Brexit may seem like the least worrying of the three potential problems for the U.S. economy in the coming months, but it is actually the most concerning. Rate hikes and tariffs can be stopped or reversed, but Brexit is a crisis that looks to be heading inexorably toward the worst-case scenario with no alternative in sight. If it sparks a recession in the E.U. and the U.K., that will inevitably spread to the U.S. and that, not the Fed or trade wars, is the real threat.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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