Where is the Consensus?

The first few days of the year provide a good opportunity to gauge the mood of the markets and assess where consensus thinking is about the economic and financial outlook and the big issues for the year ahead. Our Views for 2017, written just before Christmas, reflect our economics thoughts about the year ahead.

While the equity markets display optimism about what lies ahead, there is also considerable uncertainty and unease. Uncertainty because of the new US President and the politics of Western Europe. Unease because rates are so low, budget deficits considerable, equity markets so high and the shadow of a potential bear market overhangs bonds.

UK equities are high




While all these issues are valid and we, like the market, take them seriously, it also seems to me that there is not enough discussion about the potential upside surprises. Judging from the current debate, the risks are seen as being only on the downside.

It is worth considering whether that will be the case. While there is much conjecture about the "direct" effects of Trump and Brexit there is not enough acknowledgement of the "indirect" effects - some of which have already taken place. In the wake of the Brexit result, for instance, fiscal policies have been relaxed across many economies. Trump's victory has reinforced the need to boost domestic demand across the globe; and in the process, it could be said, pursue populist policies. Given this, plus current accommodative global monetary policies, the global economic outlook this year could yet surprise on the upside.

In that context it is interesting to note events in China. This time a year ago global markets were more worried about a potential hard landing there than anything else. Now the market mood is very different, even though there are still concerns about credit quality. President Xi's new year message was a reassuring one, mentioning the word "reform" eight times and painting the picture of policy stability and continuity.

While worries about China's economy have not figured at the start of this year, geopolitical worries have been much to the fore. Perhaps this is not a surprise in the wake of Donald Trump's election victory, Taiwan, North Korea and continuous worries about President Putin.

The Chinese currency has, however, attracted much attention this week. The Chinese authorities have made clear that they did not want the renminbi to be viewed as a one way bet: just weakening. Tighter enforcement of capital controls for individuals has been just one of the policy signals sent by the Chinese authorities this week. The Chinese currency has been firmer as a result. While the authorities may be keen to halt the depreciation, they will also not want to see it too much stronger. But it does reinforce the need to anticipate and factor potential policy changes into investment decisions.

The US Federal Reserve's rate hike in December was a long time coming but does highlight how monetary policy is now moving into a different phase. While the Fed is tightening, policy rates look set to remain low and unchanged in a number of the other major economies, including the euro zone and Japan. This could have currency implications - for instance, as some speculators and traders may opt to use the euro or yen as carry trades, borrowing in their currency to invest elsewhere. This week's release of Fed minutes reinforces the market's thinking of higher rates this year. It would not surprise me if there was a renewed focus on the need for renewed monetary discipline in the US, perhaps tied in to the thinking of the new President. If so, some of that debate about monetary policy may be seen here too. Initially that may focus on the need to end or reverse Bank of England buying of corporate bonds and quantitative easing (otherwise known as printing money).

What then is current consensus thinking on the UK?

We are more upbeat about growth than the consensus. And, perhaps for the first time in a decade, I wonder whether markets - if not all economists - may be too complacent about the potential upside risks to rates. That being said I, like the consensus, expect UK policy rates to remain unchanged this year.

To get a feel for this, consider the annual FT survey, which is as a good a guide as any to what economists are saying. Of the 121 economists surveyed, including many academics, there was a predictably cautious view. The consensus was for growth to slow from 2.1% in 2016 to 1.5% in 2017. 19 economists expected a modest slowdown, 55 a marked one. But one in five saw no change or some improvement. I was in this latter category, seeing the economy growing just over 2% this year, pretty much in line with the pace of growth in 2016.

Resilient UK growth




That FT survey also showed that economists have divided views about the inflation outlook: 42 see it above 3% and 49 between 2-3%. But the overall thinking seemed to be that there would be a temporary rise this year, and that the Bank of England's commitment to its 2% inflation target would see inflation ease as we move into 2018.

In this environment it is no surprise that when it came to views on UK interest rates, opinions are mixed. 36 economists surveyed were hawkish on the direction of policy rates this year, 62 including myself see no change and 12 were dovish.

Consumer price inflation and Bank of England base rate




One of the big challenges for the consensus is the impact of Brexit. The economic collapse and financial Armageddon widely predicted for after the referendum did not materialise. According to the FT survey this has led a handful to reassess their views and become more positive, but still the overwhelming economic consensus is pessimistic. I think they are wrong. But when it comes to 2017 it would be a surprise if markets were not vulnerable to the likely "noise" and politics surrounding EU exit negotiations. Perhaps the most interesting aspect of the political comments at the start of this year is that so few expect there to be a general election; only a few months ago a number of serious political commentators thought the Prime Minister might be tempted to manoeuvre Parliament and call an election for May.

Investors need to be aware of these political events and risks, with such low probability, high impact events needing to be assessed on an ongoing basis. The reality is, from an investment perspective, we must be aware of these factors but not allow them to divert attention from the need to focus on value and the longer-term perspective.

10 Year gilt yields still low




Here in the UK, it is clear markets are heavily influenced by the global outlook. And in this regard it is interesting to note that despite the widely diverging views about Trump the economic consensus is mildly positive. Perhaps this reflects a combination of wishful thinking as well as a reaction to how the markets are performing. Policy detail is in short supply although the impression is that Trump will try to run the US like a business, with a more direct approach towards policy decisions. For now the markets are discounting the likely good economic news associated with fiscal reflation and tax cuts, as well as a can do attitude. The potential negatives, including the potential unpredictability of policy and future trade issues have not yet been factored in. Moreover, even if the good news materialises, it will still take some time for this to feed through into earnings. Significantly though, against this backdrop, it is noticeable that the consensus is strongly dollar positive. But that too will be tested.

Despite all this, it is interesting to note that measures of market volatility are low. Let's see how long that lasts.

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