Amid market volatility and continued downside surprises in global growth, investors are focusing on the Fed and China. Regarding the Fed, the issue is whether and when it could signal potential changes in balance sheet normalisation (as it has on the policy rate path). On China, the question is when growth could stabilise. We think policy-makers will take the actions necessary to manage their countries’ respective growth trajectories. We believe that China’s growth will bottom in 1Q19, while the Fed has begun to signal some flexibility on its balance sheet policy, if there is a material deterioration in the growth outlook.

The Fed has altered its policy trajectory on rates, but not yet on the balance sheet. Despite robust trailing consumption growth and strong labour market dynamics, the US economy is unlikely to remain immune to slowing global growth. In addition, the recent tightening in financial conditions has affected capex intentions, and we expect the impact of fiscal stimulus on growth to fade in 2019. Recognising this slower growth environment, the Fed has signalled its flexibility on the policy rate path. However, the Fed has not yet given a clear signal on when the balance sheet reduction would end.

The normalisation process has not been as smooth as assumed. The Fed had anticipated that once it announced the path of balance sheet normalisation, markets would discount that “passive and predictable” pathway and that the process would be akin to “watching paint dry”.

However, we see the challenge as follows:

(1) Even though the Fed communicated the pace of the unwind well ahead of its start, uncertainty remains as regards the final, optimal size of the Fed’s balance sheet. Moreover, we believe investors are concerned that the Fed has remained on a set course, even though the US and global growth outlook has weakened.

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