The Fed has hiked 3 times this year and plans another four hikes by the end of next year. Their collective impact is still ‘in the post’ as hikes take time to bite. When we asked Charlie Jamieson, CIO at Jamieson Coote Bonds what he expects, he gave a sobering assessment of the road ahead.

Charlie warns us that: “In 2020, or late-2019, clearly there's an economic slowdown, potentially a recession. There's no question that if the Federal Reserve continues to tighten interest rates, they will at some point over-tighten; they have done in every other cycle.” In this exclusive video interview with transcript, he flags another major risk to US growth following the recent mid-term elections.

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Edited transcript

“The implications for markets are pretty severe in our opinion. I guess as we look forward into 2019, we can now discount any second type of fiscal stimulus that the Republicans would have bought collectively, and we go back more into a gridlock scenario.

We've had this huge fiscal rush in the United States, which has obviously got the economy running very hot. That starts to subside pretty naturally on its own steam going into 2019, at a time where we're already seeing a lot of parts of the economy starting to cool. For instance, U.S. housing is already in decline. New house construction is in material decline. Mortgage rates are moving up very quickly because of the Federal Reserve rate hiking cycle.

But when we think about that rate hiking cycle, there's about a 12 to 15 month lag between the rate hike and that rate hike actually affecting the economy. So, as we move through into 2019, all of the rate hikes that we've experienced this year start to filter into the dataset and will clearly tighten financial conditions.

Now, that comes at a time when global data is also quite weak and some of the lead velocity data that we follow, some of the big exporters in Asia, now Taiwan, South Korea, China, the Purchasing Manager Indices (PMI’s) have all been in material decline, and European data is pretty weak. So, it looks like we've got this tightening coming in the United States and the major implication is that because we're not going to have that second fiscal stimulus, because the Democrats won't allow Trump to go on a spending spree to essentially buy votes and popularity, it's much more likely to lead to a more normalised credit cycle.

Clearly when risk free rates have been rising, that tends to bleed to a delayed response in credit markets, and it looks like we're not going to get a late cycle , because when you go on a very big fiscal spend, clearly it keeps a lot of cashflow in the system coming off the sovereign balance sheet. That's not going to be the case, and so credit will have to stand on its own two feet into this higher rate environment, and we're already starting to see some delinquency in that space. So, that's the big one to watch for 2019.

The central scenario for the markets looking forward is 2019 is the year of the final rate hikes from the Federal Reserve. In 2020, or late '19 through to 2020, clearly there's an economic slowdown, potentially a recession. There's no question that if the Federal Reserve continue to tighten interest rates, they will at some point over-tighten. They have done in every other cycle. It's a very fine balance between trying to offset Trump's fiscal push, which is what they need to do, and build a firewall for that next cycle.

And then as we push through to 2021 there's probably a policy response. We could be in rate-cutting mode or liquidity responses like we've seen previously.

And so, with some of this lead data, we're already leading down, and we know that the lag effect has a long time to come into the market. There is a less rosy outlook as we head into 2019. Now, we're already starting to see this regime change in markets, where we've got quite colossal volatility as two equilibriums start to clash and I think we can expect that to continue.

Equity markets have been ripping around. Clearly, we had a very poor October. We've had a great response to the gridlock outlook. They like it when nothing happens in Washington but, I think, what we can be sure of is that Trump's going to spend a lot of the next two years defending investigations from the Democrats, who now have the power to table those investigations into his tax affairs, into the election with Russia, these types of things, and it's likely that he's going to get quite hostile in response.

He is a very volatile character. I think we all know to expect the unexpected from Trump and certainly, that just brings more market volatility to the table”.

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