Vol 14 (2017) - Issue 2

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2017: The Challenges of Change

The 2016 Brexit vote, the US elections, the rise of populism in Euro area countries, and rising geopolitical risks, will challenge and shape policies for the next few years. Theses policy challenges are not only about how to address the globalisation backlash, but also about how to transform this anti-globalisation movement into a viable set of domestic policies. New US fiscal initiatives will likely dominate the policy discourse during much of 2017.

I. The cyclical rebound
The good news is that the global economy has entered 2017 with improved momentum, thanks to the normalisation of the global manufacturing cycle and the shift away from global fiscal austerity. This dynamic translates into the end of a de-stocking cycle, a recovery of profit growth and the beginning of better investment growth.
The major headwinds to growth over the past few years have been the legacy of the Great Recession, the collapse in productivity growth and the end of the commodity super cycle. They delivered weak investment and very weak global trade growth, which in turn depressed activity in global manufacturing. The headwinds have faded, supporting this year’s global growth.
Moderately stronger growth in the US and steady growth in China are the major underpinnings of the global growth and commodity price outlook. Europe, Japan and specific EM economies should benefit. EM fundamentals have improved and so has market sentiment, though it has been uneven. Commodity exporters have benefited from reflation trade expectations, exporters of manufactured goods have suffered from fears of protectionism, while idiosyncratic events in other EM countries have rendered them unattractive. Differentiation is thus important, as is the direction of the USD. Rising US rates and USD strength put pressure on EM borrowers in USD and exacerbate the debt servicing burden of many of them.
Better growth implies a transition from deflation to reflation.

II. The question of a secular shift
Proponents of the various policy initiatives discussed during the US campaign and after the US elections (tax cuts, de-regulation, infrastructure spend, trade) argue they represent a secular shift and point to soaring business confidence as evidence that investment spending will accelerate dramatically fuelling a pick-up in productivity growth.
It is too early to ascertain and much will depend on corporations’ willingness to invest the potential tax dividend, and on the balance between productivity enhancing measures and potential protectionist ones (e.g., renegotiating NAFTA, immigration ban, tariffs, etc.).
Stronger productivity growth is a necessary condition for fostering both sustainable and stronger growth. In addition, many of the drivers that have produced the moderate-growth-low inflation-low interest rates trajectory of the past few years are still in place, such as low population growth, high debt levels and the global savings glut. Finally, with an economy near full-employment, additional fiscal measures could equally translate into higher inflation or stronger real economic activity.
III. Market Implications
Stocks markets are pricing in a secular shift towards stronger investment and productivity growth. Bond markets appear less convinced.
We believe that while fundamentals are better, markets are vulnerable to sharp moves in asset prices should policy mistakes or recalibration of growth and inflation expectations take place. Market challenges remain numerous:
– The divergence of monetary policies
– The Fed’s pace of normalisation
– The direction of the USD
– More frequent discussions of potential ‘tapering’ at the Bank of England and the ECB
– The growing emphasis on the use of fiscal policy and what shape it will take