Global Economic and Market Outlook for Gavyn Davies, Chairman, Fulcrum Asset Management

Transcription

1 Global Economic and Market Outlook for 2018 Gavyn Davies, Chairman, Fulcrum Asset Management

2 After many years of persistent downgrades to consensus GDP forecasts, 2017 has seen the first upgrades since the Great Financial Crash 2

3 The upgrades in forecasts for the advanced economies have been especially impressive 3

4 The upgrades in forecasts for the emerging markets have been much smaller than for the advanced economies, but have still been in the right direction 4

5 While the global expansion has been gaining strength, there has been a decline in inflation expectations during 2017 we have been in a regime of real output expansion, NOT reflation 5

6 The dominant regime since February 2016 has been of global expansion, and the performance of many (most?) macro asset prices has been driven by this regime 6

7 The fiscal stance in the US and the EA has been easing from and is likely to ease further from (see red zones below). Japan would move in the opposite direction if the planned sales tax increase is implemented in 2019 which looks dubious. (Source: OECD). 7

8 Monetary policy normalisation, measured by the level of policy rates, still has a very long way to go (Source: OECD) 8

9 Many analysts argue that the rise in asset prices has been linked to global QE. Now that the Fed and BoE have stopped increasing their balance sheets, QE is now dependent mainly on the ECB and BoJ, both of which may taper asset purchases next year. Peak QE is now well in the past 9

10 In the developed economies, the GDP recovery has been held back by a below average recovery from the slump in investment that happened in This headwind is now abating, especially in the Euro Area, where the recent rebound in investment has been quite strong. This reduces the forces of secular stagnation that have held back the global economy and have reduced the equilibrium interest rate, r* 10

11 The Washington Post points out that real GDP in the US now slightly exceeds potential GDP (as estimated by the CBO) for the first time in the recovery since the Great Financial Crash. This could be a warning signal that the top of the US upswing is close at hand, since real GDP does not normally spend that much time above potential 11

12 The Fulcrum nowcasts have performed fairly well this year, picking up the strong recovery in the EU, and the robust growth in Asia, very early. The nowcasts were, however, somewhat over-optimistic about growth in the US. The latest figures show global activity growth remaining well above trend, especially in the advanced economies. Based on these figures, the models report that recession risks are very low heading into

13 Latest nowcasts show that activity growth in the US and the EU remains very strong, at around 3.5-4% in both cases, This is well above trend, so economic slack in both economies is now declining quite sharply. Growth in Japan also remains notably above the long term trend. China has recorded a moderate slowdown since the 19 th Party Congress, but this has not so far become very serious 13

14 Latest forecasts produced by the nowcast models suggest that activity growth in the US and the EU will remain above consensus in 2018, though the growth rate will gradually fall back towards trend rates. Recession risks on a 12 month view continue to look very low, according to these models. In China and Japan, the models suggest stable or slightly lower growth rates, perhaps a little above trend. The global upswing is therefore now passing its peak growth rates, but the slowdown next year will be a return to normal, rather than the onset of recession 14

15 Although economic slack has been diminishing and the labour markets have been tightening, the Fulcrum models of underlying inflation are showing absolutely no sign yet of any rise in underlying price inflation in the US, and very little sign of any rise in the Euro Area. This is the only remaining factor preventing the Fed and the ECB from turning more hawkish 15

16 Although wage increase in most advanced economies remain low, there are now some signs that labour shortages are becoming severe 16

17 Although low wage growth in the US and other economies seems to suggest that the Phillips Curve has flattened since the Great Financial Crash, leading policymakers in the Fed have been reluctant to conclude that the PC has disappeared altogether. Using slightly different variables to measure labour market slack and wage increases, the PC does not seem to have changed much 17

18 The Taylor Rule may become somewhat more important in the setting of interest rates by the Fed, following the major change in personnel which is now underway. Most versions of the Rule indicate the current setting of rates is slightly or considerably behind the curve. Even in the Euro Area, the Taylor Rule is now starting to point to the need for higher short rates 18

19 Although the Fed has been trying to tighten monetary policy since 2015, financial conditions have actually moved in the opposite direction because of rising equity prices, declining credit spreads and a falling dollar. This easing in the FCI has been very supportive of US and global growth in 2017, and a significant reversal in these indices could be the major downside risk to US growth next year 19

20 In the developed economies as a whole, financial conditions have eased by 125 basis points since the China crisis peaked in February According to calculations by Jan Hatzius of Goldman Sachs, the impulse from financial conditions on the GDP growth rate has shifted from -1% to +0.7% over this period. This effect is now peaking and will begin to reverse soon, even if FCIs are stable from here on. A tightening in the FCI would obviously increase this headwind for global growth 20

21 The markets continue to price very dovish behaviour by the Fed and the ECB next year. Only one hike is priced for the Fed in 2018, compared to the 3 hikes shown in the Fed dots, and 3-4 hikes priced by the main economic forecasters like GS and JPM. Some of this gap may be explained by a negative risk premium on US rates, but there does seem to be considerable scope for a hawkish surprise on US policy rates next year. In the Euro Area, the market expects no change in rates at all next year, which is broadly in line with the ECB s recent guidance 21

22 China may slow in the next year as monetary and fiscal policy becomes less supportive of growth, and financial deleveraging takes some of the steam out of the property sector. However, we do not expect the new policy regime to tolerate a sharp drop in the real GDP growth rate, and the risk of a major implosion in the credit bubble still seems to be under control for the time being 22

23 A 1% downward shock to Chinese GDP growth is likely to reduce growth in the advanced economies by per cent over two years, while having a meaningful negative impact on commodity prices Metals Prices Oil Prices 23

24 Equity valuations are in red territory for the US, Europe and Germany. They are in amber territory for the EM, and Japan is the only major economy where they edge into green figures. Real bond yields obviously flash red everywhere, as do credit spreads. Because bond yields are so low, ERPs are not as stretched as P/Es. The dollar is slightly overvalued, with most other major currencies undervalued against it, especially the yen. All these valuations are relative to 20 year histories, calculated by Morgan Stanley 24

25 Fulcrum maintains a regular BVAR model for the main asset returns in the US. This model produces forecasts for asset class valuations, interest rates, inflation and GDP. The latest forecasts for 3 year real returns are shown here. Equities and credit are expected to produce low single digit returns, while bonds and cash produce negative real returns in the model. The expected returns on risk assets have fallen fairly sharply during 2017, reflecting the rise in valuations over the recent period 25

26 The graph shows the valuation of the major currencies against the US dollar, using an average of three different methods to calculate FX fundamental valuations. (Negative numbers imply that the currency in question is undervalued against the dollar.) Most currencies are undervalued at present vs the USD, but the decline in the USD this year has reduced these undervaluations considerably. The EUR is now undervalued by 11%, compared to 22% at end 2016 Currency valuations vs USD (-ve implies undervalued vs USD) Calculations by Fulcrum fixed income research EUR 26