What are the key questions, dates, and indicators we're looking at for 2017.
I hope that many of you have already had the chance to delve into our annual Year Ahead outlook. We address key questions we’ve been hearing from investors and set out our top investment ideas for the new year. Our online “End Game” simulation has also proven popular as investors seek to understand the potential consequences of new policies on markets and economies.
While our outlook publication offers a fuller picture of the world, I want to use this space to examine some questions we will be asking ourselves over the next 12 months, as well as highlight major upcoming market events and provide an update on our latest tactical asset allocation.
A new dawn or a political hangover?
Some investors have quipped that it took days for the markets to digest the UK referendum outcome, hours to come to terms with Donald Trump as President-elect, and minutes to assess Italian Prime Minister Matteo Renzi’s resignation.
Yet we will only develop a truer sense of how these political changes affect real economic outcomes over the course of next year. We will learn whether the proponents of a “hard” Brexit in the UK government will get their way, or whether parliamentary debate and EU negotiations will lead to a middle ground. We will see if greater European growth can further unite the common market or if nationalism gains support. The composition of China’s new Standing Committee at the 19th National Congress should provide guidance as to the government’s appetite for further economic reform. And we will discover whether incoming president Trump’s more radical policy pronouncements, for instance on trade, can survive the checks and balances built in to the US political system.
Potential changes in policy around the world, particularly a shift toward fiscal rather than monetary stimulus, hold out the promise of faster economic growth but also the possibility for mishaps in a complex global system. The extent to which politicians can enact radical policies will also test the strength of the global policy framework. We don’t take it for granted that political events in France, the Netherlands, Germany, Italy, and China will always be absorbed smoothly.
We will continue with our strategy of avoiding strong investment views based on binary political events, while remaining mindful of the investment opportunities political outcomes can produce.
Key dates: 20 January – US presidential inauguration; 15 March – Dutch general election; by 31 March – UK expected to trigger Article 50 to begin negotiations on leaving the EU; 23 April – French election first round; 7 May – French election second round; October – 19th National Congress of the Communist Party of China; Autumn – German federal election.
Key indicators: The British pound; the euro; the US dollar; US 10-year yields.
How wide is the Atlantic? The Fed and the ECB.
At its December meeting the Federal Reserve raised interest rates by 0.25% to 0.50– 0.75%, almost exactly one year after its previous hike. Interest rates futures markets had priced in an almost 100% probability of a rate rise, so markets focused more on the Federal Open Market Committee (FOMC) “dot plot,“ which showed participants now forecasting three 25 basis point rate rises next year, up from two previously. This was initially taken as a hawkish signal by markets, with the US dollar rallying and stocks initially retreating.
The coming year will show us the extent to which Fed policy can “decouple” from that of central banks in Europe, the UK, Switzerland, and Japan. The dollar has risen in recent weeks on expectations that the Fed is in a position to hike repeatedly. Meanwhile, the euro has weakened in anticipation that European Central Bank (ECB) plans to trim quantitative easing (QE) might be scuppered by political uncertainty. The yen has also depreciated on expectations that the Bank of Japan (BoJ) could be forced to defend its “yield cap” more aggressively if US Treasury yields continue to climb.
Although investors are positioning for a significant rate decoupling, we believe the relative rise in US borrowing costs is likely to be capped by inflows from investors starved for yield in the rest of the world. Currency moves can also narrow monetary policy gaps. For instance the ECB might be more inclined to taper QE in light of the euro’s recent weakness against the US dollar. Similarly the BoJ might defend its yield cap with less zest if USDJPY goes on rising. US monetary policy does not operate in a vacuum either. Expectations of rate hikes last year were dashed by international events – turbulence in China at first, then political uncertainty wrought by the Brexit vote. Investors should not completely discount a comparable outcome this time.
Our base case is for the Fed to hike rates only gradually next year, and for the ECB to scale back its QE program. We therefore maintain our preference for the euro over the US dollar.
Key dates: Fed meetings: 31 January– 1 February; 14–15 March; ECB meetings: 19 January; 9 March.
Key indicators: Fed funds futures; US dollar; euro; US vs EU 5-year yield differential.
Will inflation help or hinder markets?
There are increasing signs that inflation and inflation expectations are on the rise. US wage growth is running at its fastest pace in eight years, according to the Atlanta Fed’s Wage Growth Tracker. Trump’s electoral victory brings with it the potential for fiscal expansion at a time when unemployment is already low. And the recent spike in oil prices, thanks to production cuts from OPEC and non-OPEC countries alike, should magnify year-over-year increases in energy costs.
For now, equities have taken these developments in stride. Inflation holds out the promise of higher nominal growth (facilitating deleveraging) and of greater pricing power for companies. Time will tell whether markets remain upbeat about these prospects or whether they will begin to view inflation as a threat. A tipping point could be reached if central banks shift their focus from stimulating employment and growth toward dampening rising prices. Equally, markets could grow anxious if the oil price continues to climb, reducing the disposable income of consumers and squeezing corporate margins.
We will monitor central bank policymaking, the trend of real consumer spending, and the evolution of profit margins through the coming year. But we enter it expecting the increase in core inflation to be moderate enough to allow central banks to persist with their loose policy stance, even if they tighten slightly. The ECB, for instance, stressed that it was not “tapering” QE when it announced it would extend its bond-buying program in December. And Fed Chair Janet Yellen reiterated on 14 December that only “gradual” rate hiking was likely to be warranted in the next few years. She also described the higher rate forecast from FOMC members in the “dot plot” as “really very tiny” – which we interpret as further evidence that she remains committed to cautious tightening.
We approach the coming year with a positive stance on equities, overweighting them in the US versus government bonds, and in emerging markets versus the more defensive Swiss index.
Key dates: US PCE and core PCE index: January 30 and March 1; final Eurozone HICP inflation: 18 January and 22 February.
Key indicators: US and euro inflation swaps; US 5-year TIPS breakeven inflation rates, developed market sovereign bond yields.
Can profit growth justify valuations?
The sell-off in bond markets has not just been a headache for fixed income investors. The move higher in risk-free yields has, on some measures, also reduced the relative attractiveness of equities. This was part of the reason we recently trimmed our US equity overweight relative to government bonds. The equity risk premium, a measure of relative value, has fallen from 4.2% in September to 3.2% now, which is still attractive in a historical context (the long-run average since 1960 is 2.6%) but less so.
Equity investors will be looking for profit growth next year to justify valuations. The good news is that there is scope for an acceleration, particularly in the US and the emerging markets, where we expect earnings to increase approximately 11% and 5% respectively.
Investors can continue to hold into next year assets that benefit from economic and corporate revenue growth as fundamentals improve and central bank policy settings around the world remain stimulative. But we will be training a watchful eye on earnings growth and valuations to evaluate our equity positioning.
Key dates: January/February – fourth-quarter earnings season.
Key indicators: Equity market price-to-earnings ratios; 10-year bond yields
Tactical asset allocation
In our global tactical asset allocation we enter the new year with a pro-risk stance. We are overweight US equities relative to government bonds. Faster GDP expansion, improving earnings, and only gradual interest rate increases should support the US stock market. We are also overweight emerging market (EM) equities relative to Swiss ones. We expect EM growth to speed up as earnings revisions have improved notably, while the more defensive Swiss market, whose valuations exceed long-term averages, could lag in an accelerating global economy.
In fixed income, we maintain a US Treasury Inflation Protected Securities (TIPS) overweight relative to government bonds, given our view that US inflation expectations are likely to continue to rise.
In currencies we favor the euro relative to the US dollar. The euro remains significantly undervalued on a purchasing power parity basis, and the Eurozone’s current account surplus should offer further support to the single currency in coming months. In addition, we favor a EM foreign exchange basket (composed of the Brazilian real, Indian rupee, Russian ruble, and South African rand) relative to a developed market foreign exchange basket (the Australian and Canadian dollars and the Swedish krona). The position currently has an 8.0% carry and an attractive potential return in a low-yield world.
Happy holidays and I wish you all the best for a healthy and prosperous year ahead. And stay tuned for my holiday video - coming next week.
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8yTop-10 economic predictions for 2017 20 Dec 2016 - IHS Economics and Country Risk The political earthquakes of 2016 have upended conventional thinking about the global economy and have—ironically—brightened the outlook. The expectation that the incoming Trump administration will enact sizeable fiscal stimulus has increased optimism about US and global growth. This, in turn, has pushed US stock indexes to record highs, while pushing up interest rates (with a resulting rout in the bond market) and the dollar. A stronger dollar is mostly good news for Europe and Japan, helping to boost export growth and inflation expectations. On the other hand, much higher US bond yields are bad news for the emerging world, where currencies have already taken a beating in recent weeks, significantly reducing the scope for further monetary easing. Fortunately, these financial market gyrations are occurring when commodity prices are rising and consumer and business sentiment have improved. IHS believes the balance of these trends will be moderately positive for global growth, which should strengthen from 2.4% in 2016 to 2.8% in 2017 and 3.1% in 2018. That said, high levels of political and policy uncertainty could hurt growth in 2017 and beyond. 1. The US economy will accelerate—even before any Trump stimulus. US real GDP growth was pushed down in 2016 (to 1.6%) by the combined effects of a large inventory drawdown, the collapse in energy-sector capital spending, and the drag from net exports because of a strong dollar and weak global growth. The good news is that during the coming year, a much smaller drag from inventories and a rebound in energy-sector capital spending (the closely watched rig count is already moving up) will boost growth. IHS expects tax cuts (likely close to the more-modest House Republican version) and infrastructure spending (probably scaled back from the Trump proposal and phased in) will be enacted early in 2017. The stimulus will not have much of an impact on 2017, but could boost 2018 growth as much as 0.4 percentage point. Consumer and business confidence, which rebounded right after the election, are likely to be boosted further as growth improves. On the downside, the rise in interest rates and the dollar, in anticipation of stimulus, will erode some of the positive effects of stimulus. IHS currently predicts US growth will accelerate to 2.3% in 2017 and 2.6% in 2018. 2. Europe’s economic momentum will slow a little, primarily because of Brexit and political uncertainties. Incoming data on the Eurozone economies point to a near-term rebound in growth, while the UK economy is proving resilient. In particular, consumer and business surveys (including the Markit purchasing managers' indexes—PMIs) underscore the better mood in Europe. Nevertheless, Europe faces daunting political challenges that could hurt confidence and growth in 2017. These include a potentially contentious Brexit, fallout from the recent referendum defeat in Italy, and upcoming elections in France, Germany, and the Netherlands. In particular, the political turmoil in Italy could trigger a crisis in the banking sector, which is already in dire straits. On the positive side, the European Central Bank has extended its bond-buying program (albeit at a more modest pace), and a weaker euro will help to lift export growth and (along with rising oil prices) raise inflation rates. IHS continues to believe these conflicting forces will weaken Eurozone growth from 1.7% in 2016 to 1.4% in 2017. Likewise, we expect UK growth to fall from 2.1% in 2016 to 1.3% in 2017. The good news is the Brexit impact has been small, so far. The bad news is it will likely worsen soon. 3. Japan’s growth will be low and steady, helped by a weaker yen. Recent data on Japan have also been upbeat, although the source of much of the recent growth rebound has been net exports—domestic demand growth remains lackluster. The recent plunge in the yen is likely to accentuate these trends. The weak yen will fuel exports and tourism, support corporate profits (which are now around 11% higher than a year ago), lift capital spending, and encourage further increases in stock prices. On the downside, higher import prices (and overall inflation) will erode the purchasing power of consumers and suppress consumer spending. With inflation moving up, the Bank of Japan will probably hold off on any additional stimulus. Moreover, the likely demise of the Trans-Pacific Partnership diminishes the chances of meaningful structural reforms in Japan. On the other hand, the fiscal package passed by Japan’s parliament in October, albeit modest, will provide earthquake relief and more infrastructure spending. On balance, IHS believes Japanese growth will hold steady at 1.0% in 2017. 4. China’s growth will grind down further, led by a housing construction slowdown. China’s economic condition remains fragile in late 2016. Industrial production and real retail sales growth rates have held steady, but real fixed investment has continued to decelerate. Entering 2017, China’s economy faces headwinds from a deflating real estate bubble and a cyclical deceleration in automotive production and sales as a temporary tax break expires. One counterweight is the improved performance of mining and some heavy industries, as manifested in the ability of these sectors to raise prices, after years of deflation. Yet, China faces another source of stress from capital flight. Foreign-exchange reserves are at a five-year low and the renminbi is back to 2008 levels. In response, the government is imposing capital controls in an attempt to relieve pressure on the currency and limit annual depreciation to no more than 6%. Amid policy contradictions, we expect China’s growth to slow from 6.7% in 2016 to 6.4% in 2017. 5. Emerging markets will do better, despite recent financial market pressures. The results of the US election are something of a good news/bad news story for emerging markets. On the plus side, moderately stronger growth in the US and global economies is good news for emerging markets whose economies are export-oriented. Moreover, the expected continuing rise in commodity prices will help to bring in more export revenues and replenish government coffers. On the downside, plunging currencies are unwelcome for at least two reasons. First, to prevent further capital flight, central banks have to pursue more restrictive policies than they would like. Second, dollar-denominated debt in the emerging world has risen rapidly in recent years, reaching around USD3.5 trillion. As the value of the US dollar goes up, so does the burden of these debts. The good news is the economic fundamentals (e.g., current-account deficits) in most emerging markets have improved in the past couple of years. Also, with the exception of China, overall debt ratios (domestic and foreign) are mostly down. Therefore, these economies will be able to enjoy the fruits of a more upbeat global outlook. 6. Commodity prices will continue their upward trend. Between, January and September 2016, commodity prices (as measured by the IHS Materials Price Index) rose more than 40%. Subsequently, they retreated a little through early November and then surged after the US election. Earlier, expectations of a slight pickup in growth and better supply management fueled the recovery in prices. In the past few weeks, anticipation of even stronger growth and, in particular, more infrastructure spending by the United States has buoyed commodity markets. The euphoria may be overdone, as US commodity consumption is only about one-fifth that of China. Nevertheless, IHS does expect commodity prices to continue to move up. The recent OPEC agreement to cut output (by about 2% of world liquids production) will help support oil prices by turning a small surplus in production into a deficit. As a result, IHS has nudged up the average oil prices forecast for 2017 by a few dollars, to USD54/barrel for dated Brent. Here again, market optimism should be tempered. OPEC members have a long history of less-than-100% compliance with output cuts. Perhaps even more important, rising oil prices will encourage more US production, which will dampen any future price increases. 7. Inflation rates will move up in many parts of the world. After many years of facing the threat of deflation, the developed world economy is on the threshold of an increase in inflation. With the US economy at or near full employment, wage inflation is already beginning to rise and is set to climb even faster with the implementation of fiscal stimulus. Along with increases in commodity prices, this will translate into faster price inflation (exceeding 2% in the coming two to three years). A similar upward trend is also evident in other parts of the world. Consumer price inflation is at a 31-month high in the Eurozone (although still low at 0.6%), and deflationary pressures in Japan are beginning to ease. Even more notable is that after many years of falling, China’s industrial prices have risen recently. Rising inflation in the US economy, accompanied by a stronger dollar, means the United States will be “exporting” inflation. Specifically, falling currencies in other parts of the world mean higher imported and headline inflation. For example, IHS believes Japan’s consumer price inflation will swing from -0.1% in 2016 to 1.1% in 2017. UK inflation could well end 2017 around 3.0%, compared with 0.9% currently. 8. US interest rates will keep rising—also pulling rates up in some emerging markets. Even before the recent US presidential election, financial markets expected the Federal Reserve to raise interest rates in December 2016 and twice in 2017. After the election, with expectations of a larger US budget deficit and higher growth and inflation, IHS predicts the Fed will raise interest rates even more in 2017 (at least three times) and keep raising rates until the overnight federal funds rate reaches 3.0% by the end of 2019. In anticipation of more rate hikes, markets pushed the 10-year Treasury yield roughly 50 basis points higher soon after the election. Elsewhere, anxiety among central banks has risen recently. The Bank of England and the European Central Bank have warned that higher interest rates in the United States and political uncertainty on both sides of the Atlantic could “reinforce existing vulnerabilities” in the global financial system, especially in the emerging world and Europe. Higher US interest rates have triggered a run on emerging-market currencies, forcing some central banks (e.g., Mexico and Turkey) to raise interest rates and others to halt any further rate cuts (e.g., India, Indonesia, and Malaysia). In Europe, there are concerns about banking problems and a new round of sovereign-debt pressures. 9. The US dollar will appreciate more. An already-strong dollar climbed even higher in the wake of Donald Trump’s victory. By the end of November, the dollar had risen to an 8-month high against the yen and a 20-month high against the euro. Some of its climb was due to the US election, but some was due to anxiety about the Italian referendum. Emerging-market currencies were also hit hard. In Asia, exchange rates fell between 2% (offshore Chinese renminbi and Thai baht) and 7% (Japanese yen). In light of expected stronger growth in the US economy and higher interest rates, IHS predicts the greenback will keep appreciating in the next year. On an effective (trade-weighted) basis, we expect the dollar to rise another 3% in 2017. The advance of the US dollar will not be uniform. The biggest increases are likely to be against the euro and the yen, as monetary policies in the Eurozone and Japan will be more accommodative than in the United States. We forecast that by the end of 2017, the euro will briefly touch parity and the yen will fall to around 120 per dollar. On the other hand, emerging-market currencies will fall much less, because many have already seen large declines. Currencies of commodity-exporting countries will get a boost from the recovery in commodity prices. 10. The level of uncertainty has risen, but the risks of recession remain low. IHS estimates the risk of either a US or global recession in 2017 is no more than 25%. The usual “recovery killers” are in abeyance. To begin with, even with the Fed expected to raise interest rates during the next year, global monetary conditions remain extremely accommodative. Thus, chances of central banks killing off the recovery are slim to none. Second, despite the recent OPEC agreement to cut production, global oil markets are well supplied. The risk of an oil shock is low. Finally, notwithstanding the recent euphoria in US equity markets, there is little (if any) evidence of asset bubbles in most parts of the world. In other words, the odds of a repeat of the 2008–09 financial crisis are fairly remote. Unfortunately, political and policy uncertainties (and risks) are higher now than they were a year ago. The rise of antiglobalization movements in the United States and Europe could result in policies that hurt growth. In particular, a trade war could push the US and global economies into recession. On the other hand, business-friendly policies (including lower corporate taxes and a roll-back of regulation) could boost both short-term and long-term growth.
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8ylet's hope this year's predictions will be proved near reality......
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8yGood Luck 2017 à new gréât year.
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8yWill interest paid on Excess Reserves be correlated to the FFR or linked to inflation expectations or actual inflation?