Financial markets have been jarred by uncertainty of late. US stocks had their worst December performance since the Great Depression in 1931. Also in the same month，the price of Brent oil slid 8.93% while COMEX gold prices were up 4.9%. US ten-year Treasury yields fell a sharp 9.12%. Although the first meeting of the US Federal Open Market Committee (FOMC) this year suggested the Federal Reserve would raise interest rates twice in 2019，the market saw a 35% probability of an interest-rate cut before the end of the year. JP Morgan saw a 91% chance of recession in the US in 2019 as indicated by its model based on the stock market，credit spreads and the yield curve.

But there were also some positive notes. The US stock market posted 11 consecutive trading days of gains from January 4 to 18 and the Dow added 11.1% in the first two months of the year ¨C its best performance since 2009. The appetite for risk was clearly reviving.

But economic growth has lost momentum. The global economic recovery from the 2008 financial crisis had been driven largely by debt and monetary easing. There is no evidence of a significant improvement in global productivity.

Low Inflation

Low interest rates and low inflation have persisted while returns on investment remain under pressure. The median forecast by the Fed of the natural rate of interest has fallen from 4.25% in 2012 to 2.75%，despite the gradual rise in still low market interest rates. Inflation in the core eurozone countries has not exceeded 2%. Moreover，data show that the European Central Bank has been over-optimistic in its assessments of the economy and inflation. It has been forecasting an upward trend in inflation since the end of 2013，but data suggest more low inflation. Additionally，leverage levels are rising in emerging markets and more developed economies. Productivity has not improved significantly. This suggests low gross domestic product growth ¨C even with the help of a heavy dose of debt.

Additionally，the effects of stimulative fiscal and monetary policies are waning. US fiscal policies helped boost economic growth in 2018 even as global growth slowed. Tax cuts took effect during the year，widening the fiscal deficit. But they helped attract between US$0.57 trillion and US$1.1 trillion in retained earnings held overseas in the first three quarters of 2018，according to data from the European Banking Authority. This added liquidity to the market as the Fed reduced its balance sheet. The stimulative effect on growth was obvious. However，the policies were pro-cyclical because they were taken when the GDP output gap (the gap between actual output and potential GDP) was rapidly narrowing. Policy-led impetus to economic growth will diminish in 2019，even discounting the impact on policy measures from the bitter partisan divide between the Republicans and Democrats. In Europe，the eurozone has maintained a relatively tighter fiscal policy. In Asia，Japan will start fiscal contractionary policies in the fourth quarter of 2019 with an increase in the consumption tax. Generally，counter-cyclical fiscal policies are likely to be in effect around the globe during the year.       

Moreover，trade protectionism has risen markedly as the lack of effective growth engines has led to fiercer global competition. That is the root of the US trade friction with China and Europe. Against this background，the combined volume of global imports and exports rose 4.6% year on year in September，down sharply from a high of 17% in January. Weakening global trade will further impair the effective allocation of resources，and in turn exacerbate trade friction.

Easier Monetary Policies

Global liquidity began contracting in 2018，mainly because of the economic situation in the US and China. China has already started to adjust its monetary policies. While the Chinese central bank says it maintains a policy of being "neither too tight nor too loose," there are indications of more monetary easing. The central bank has injected liquidity into specific areas of the economy by means of its targeted medium-term lending facility and has made several cuts in the bank reserve requirement ratio. These actions have been aimed at keeping interest rates in the money market low and ensuring that monetary easing translates into more available credit. On the other hand，dollar-denominated borrowings are likely to expand in 2019，as the renminbi appears to be set to strengthen. Efforts to open up the financial market will attract inflows of capital from overseas and that points to an appreciation of the Chinese currency ahead.

In the US，it is likely that the Federal Reserve will ease monetary policies in the near future. Tighter monetary policies have already led to slower US economic growth，and slower growth in the property market has been particularly evident. Meanwhile，the stock market remains volatile. If the Fed sticks to plans to reduce its balance sheet throughout 2019，there will be a negative impact on growth. While the Fed began unwinding its balance sheet positions in 2018，the European and Japanese central banks were still buying assets. This added to global liquidity. The US benefited from inflows of funds parked overseas due to the tax reform，while other capital was attracted by the rising US equity market and relaxed financial regulations. But these factors may dissipate in 2019. When the Fed is making monetary policy decisions it will take into account the performance of the equity market.

The Fed is likely to adjust its monetary policies before economic data worsens. So far there has been no further interest rate hike this year and a pause in the reduction of the Fed's balance sheet is possible by mid-year. This prediction is based on past experience. In 1990 and the years between 2007 and 2011 there were interest rate cuts by the Fed following bouts of fierce volatility on the equities market. However，there was a negative example in 2000，when the unemployment rate slipped to a low of 3.8%. The Fed increased interest rate six times from 1999 to May 2000，ignoring high volatility in the stock market. As a result，the market tumbled and unemployment rose quickly. Although the Fed decreased interest rates soon after the stock market setback，the US economy had already been hammered. Will the Fed fall into the same trap again?

Looking back，we can see a turning point in global liquidity. Since October 2018 the year-on-year growth in the balance sheets of the US，European，Japanese and Chinese central banks has been negative. This was the first period of negative growth since 2004. In the years between 2004 and 2018，every time the growth rate was about to slip below zero，easier monetary policy helped avert a further decline.

European and Japan central banks will not take big steps in tightening their monetary policy though they are stepping back from quantitative easing.

The eurozone economy has performed worse than expected in recent months，European Central Bank President Mario Draghi told the European Parliament in January. He said significant monetary stimulus is still necessary，though he added that no recession was likely in the eurozone. At its December 2018 meeting，the European Central Bank indicated it did not expect a rate hike until the end of 2019，and made it clear that it would continue to roll over its investments beyond the first rate hike. That suggests that monetary tightening is unlikely before the end of this year.

Japan's Tax Hike Plan

The situation in Japan also does not argue for austerity. Monetary easing is needed to offset the potential shock to the economy of a planned consumption tax increase. Japan will boost its consumption tax from 8% to 10% in October of this year. The increase is a bid to fulfill a campaign promise of Prime Minister Shinzo Abe of compulsory early childhood education and a reduction in the fiscal deficit. The Japanese economy is likely to be affected by this action in the fourth quarter of this year ¨C repeating the pattern of a previous hike in the same tax. After the announcement of plans for a consumption tax increase from 5% to 8% in October 2013，durable goods consumption in Japan initially surged. But the growth in sales of consumer goods fell off a cliff after the increase took effect in April 2014.

Politically，monetary tightening may not be welcomed by the Abe administration. It is not willing to see possible economic and financial turbulence created by tightening，considering that elections for the upper house of the Diet will be held this summer. If the Liberal Democratic Party suffers an electoral setback，its plan for a constitutional amendment in 2020 will collapse and support for the Abe government could be in jeopardy.

As mentioned earlier，monetary easing will support the economy in 2019 while trade tension is expected to ease.

China and the US have achieved substantial progress on specific issues following their seventh round of talks in February this year. China will take more measures to expand market access and protect intellectual property rights and the US has delayed its threatened increases in tariffs on imports of Chinese goods scheduled for March 2019. However，the dispute over core issues，such as industrial policies and competitive neutrality，will not be resolved anytime soon. 

That means the likely scenario is temporary truces that punctuate a lengthy dispute. The friction between the two countries appears to be the result of imbalanced trade，but the real source is associated with the so-called ¡°Thucydides Trap,¡± which postulates that conflict between a rising power and an established power is inevitable. In fact，China's direct threat to the US at the trade level does not seem pressing. The US-China trade deficit as a proportion to the US total trade deficit has declined since 2015，and is less than the proportion of the US-Japan deficit in the early 1990s. In addition，some news reports have suggested that China will substantially increase US imports to the point where the Chinese trade surplus with the US could be eliminated by 2024. At the same time，the economic race between the two countries has intensified. China's share of global GDP continued to rise to more than 15% in 2017，while the US share has fallen since the subprime crisis in 2008. In the eyes of the US，the trend is worrisome.

Both China and the US are eager to reach a ceasefire agreement. The two economies are bound together in the existing global supply chain. About 70% of China's exporters focused on the US market have foreign investment. Nearly half of these investments are from the US or Taiwan (37% and 12%，respectively). The US-China trade dispute will have a great impact on the US economy as  demand and income of those enterprises are affected. The recent economic slowdown and the repeated bouts of turbulence

on financial markets are signs of that impact. The Trump administration is placing its priorities on the economy ¨C ahead of other concerns such as

immigration and geopolitical problems. At the same time，from the perspective of China's core interests，the best outcome is that the conflict is confined to the economy and trade and not expanded to the geopolitical and ideological arenas. So it is reasonable to conclude that a path around an escalated level of tension could be found.

Two factors are usually cited as indicators of a recession around the corner in the US. One is the likelihood of a housing crash and the other is the prospect of an inversion of the yield curve on US treasuries. Looking at these indicators，it is too early to say a recession is looming.

First of all，the pressure from a fall in the housing market is still manageable，especially taking into account monetary easing by the Fed. According to The Economist magazine the decline is not yet in the danger zone. Housing starts fell by an average of 22% in the four quarters before previous US recessions from 1960 to 2007. However，the drop in housing starts over the last four quarters was only 3.6%. Additionally，the US housing market is not overvalued. Though the marginal rate on mortgage loans is rising，interest rates are not high. The Standard & Poor's Case-Shiller home price indices of 20 metropolitan regions fell year on year after reaching a high of 6.76% in March of last year. Interest on a 30-year fixed rate mortgage stopped rising after reaching 4.87% in November. In contrast，the data was rather higher before the slowdown in the property market in December 2005. Interest on mortgage loans at that time was 6.27%，and housing price indices were up 15.5%，much higher than the growth reached in the same period last year.

Secondly，although a recession followed each time the 10-year treasury yield fell below the two-year treasury yield，this has not yet been repeated. Looking at the five recessions since 1975 (1978，1980，1988，1998 and 2006) we see the yield curve inverting for an average of 627.2 days before each recession. (There was also a 1% - 31% rise in the stock market during the same periods). If we take a starting point of December 5，2018 ¨C when the spread between the 10-year and two-year treasury yields dipped to a low of 11 basis points ¨C we could say the next recession would not appear until September 2020. But the yield curve，while close to inverting，has not actually reached that point. So far the possibility of a recession in 2019 appears to be limited. 

Zhong Zhengsheng is chairman and chief economist at Monita Research，Caixin Insight

Zhang Lu is senior macro analyst at Monita Research，Caixin Insight