Economic Update
Where are we now? For Western economies, the 2008 Global Financial Crisis was a game changer. It ushered in a period of low growth and low inflation. This led to fears of ‘secular stagnation’, the worry being that economies would not be able to break out of this cycle. Despite this, recent years have witnessed diverging growth across Western economies, with the US in particular growing solidly and outperforming.
Jobs growth, too, has been solid across many economies. Yet worries about the sustainability of growth have persisted, as recoveries in most countries since the financial crisis have been weak by historical standards. This is particularly so in the UK. Inflation has been low globally, and spikes in inflation, whether because of devaluation as in the UK, or peaks in oil prices, have not been sustained.
Unconventional policies are set to persist
In this environment we have become accustomed to unconventional policies, particularly in monetary policy. The years following the crisis witnessed low rates, booming balance sheets of central banks and ample liquidity via quantitative easing.
And while the last few years have seen the US, UK and to a lesser extent the ECB tighten policy, this now looks set to be put into reverse, or at the very least, a period of further policy accommodation. Indeed, while others were tightening, the Bank of Japan pushed policy activism even further, supporting its domestic markets and now the question is whether this will be a template for others to follow?
Indeed, there is now talk of modern monetary theory (which advocates using monetary policy to achieve wider economic objectives) in the US, albeit in political circles, and some discussion in the UK of whether monetary policy can be used to address its productivity problem. All this suggests unconventional policies may be with us for some time.
Meanwhile, global debt levels are high, reaching 318% of GDP last autumn, and pro-growth policies, aided by fiscal stances, have become more established, as seen with both Trump economics; and Abenomics. Fiscal policy is also being used more pro-actively in China, following a slowdown there last year.
The growing impact of global political change
The slowdown in China, though, highlights the increasing importance of emerging economies. If it was to grow at 6.5%, at the top end of the official range for the year, it would add an economy the size of the Netherlands, the 17th largest in the world. Emerging economies will continue to account for more of global growth, hence markets are taking increasing notice of not just policy in China but also elections elsewhere, such as Nigeria earlier this year and in India this summer.
Indeed, it is not just the economic and policy picture that is changing, so too is politics. Thus, for the markets, the political cycle across the globe is of growing importance. We have witnessed the rise of populism, greater questioning of globalisation and divergence between global, regional and local needs.
While in the UK the 2016 Referendum result has ushered in a political crisis, the EU too has seen the rise of euro scepticism and with European elections this summer this could become more of an issue. Meanwhile, President Trump has challenged the world on issues such as paying for NATO and on trade policy. As we are now in the early stages of the 2020 US Presidential Election and are yet to see the Brexit crisis reach a conclusion, the political divide may become more acute.
Now, where we are in the cycle is a hot topic
For markets, the current hot topic is where we are in the cycle. Financial markets have been caught out by cyclical changes, both by the global rebound in 2016 and by the slowdown that took place in the second half of last year.
A number of factors contributed to that slowdown, not least policy tightening in the US and the expectation at that time that this would continue. Worries about China added to the mix, as a policy-induced slowdown in domestic demand was exacerbated during 2018 by fears over the deteriorating trade dispute with the US.
The euro area, too, continued to lose momentum, reinforcing the gloom that impacted equity markets in the final few months of last year. After that equity market correction, and the subsequent rebound, we are now in an interesting situation.
Equity markets, it would seem, expect growth to recover. Bond markets, meanwhile, are anticipating a downturn and a possible recession. This does not, however, mean that a market correction for either bonds or equities is inevitable. Indeed, the actions of central banks, in order to offset the downside risks, will likely allow both equities and bonds to be underpinned for now. Markets, though, could be more volatile in response to changing economic data and sentiment.
While there has been a flight to quality, particularly in government bonds, especially in the euro area and the UK, low policy rates and the possibility that central banks including the US Fed may now ease, has allowed high yielding debt to rally, too. As before, when rates were low, the fear is that markets may not be pricing properly for risk.
Three possible outcomes, underpinned by uncertainty
The issue, though, is this: what will follow the recent slowdown? Three broad options are possible: one is stabilisation followed by modest to steady growth; the second is economic weakness and possible recession. In turn, there appears to be little expectation of the third option coming into play – namely, a strong rebound along with a possible rise in inflation. We expect monetary policy accommodation to help stabilise economies. But global growth will slow this year compared with last.
All this uncertainty is also reflected in the UK. Raw politics will determine the Brexit outcome. Still, there are a range of options, including the PM’s “deal” followed by a transition period, no deal, an extension of Article 50 or, perhaps, even a customs union.
Although UK economic data is mixed, the two indicators that suggest the economy is growing strongly are ones that are rarely revised: the employment data and tax revenues. Meanwhile, the GDP figures, which are frequently revised, suggest only modest growth, held back by sluggish investment, as we have outlined previously.
As the markets wait to see how the politics unfolds, expect UK policymakers to retain a bias to ease.
Please remember that when investing your capital is at risk.
Jobs growth, too, has been solid across many economies. Yet worries about the sustainability of growth have persisted, as recoveries in most countries since the financial crisis have been weak by historical standards. This is particularly so in the UK. Inflation has been low globally, and spikes in inflation, whether because of devaluation as in the UK, or peaks in oil prices, have not been sustained.
Unconventional policies are set to persist
In this environment we have become accustomed to unconventional policies, particularly in monetary policy. The years following the crisis witnessed low rates, booming balance sheets of central banks and ample liquidity via quantitative easing.
And while the last few years have seen the US, UK and to a lesser extent the ECB tighten policy, this now looks set to be put into reverse, or at the very least, a period of further policy accommodation. Indeed, while others were tightening, the Bank of Japan pushed policy activism even further, supporting its domestic markets and now the question is whether this will be a template for others to follow?
Indeed, there is now talk of modern monetary theory (which advocates using monetary policy to achieve wider economic objectives) in the US, albeit in political circles, and some discussion in the UK of whether monetary policy can be used to address its productivity problem. All this suggests unconventional policies may be with us for some time.
Meanwhile, global debt levels are high, reaching 318% of GDP last autumn, and pro-growth policies, aided by fiscal stances, have become more established, as seen with both Trump economics; and Abenomics. Fiscal policy is also being used more pro-actively in China, following a slowdown there last year.
The growing impact of global political change
The slowdown in China, though, highlights the increasing importance of emerging economies. If it was to grow at 6.5%, at the top end of the official range for the year, it would add an economy the size of the Netherlands, the 17th largest in the world. Emerging economies will continue to account for more of global growth, hence markets are taking increasing notice of not just policy in China but also elections elsewhere, such as Nigeria earlier this year and in India this summer.
Indeed, it is not just the economic and policy picture that is changing, so too is politics. Thus, for the markets, the political cycle across the globe is of growing importance. We have witnessed the rise of populism, greater questioning of globalisation and divergence between global, regional and local needs.
While in the UK the 2016 Referendum result has ushered in a political crisis, the EU too has seen the rise of euro scepticism and with European elections this summer this could become more of an issue. Meanwhile, President Trump has challenged the world on issues such as paying for NATO and on trade policy. As we are now in the early stages of the 2020 US Presidential Election and are yet to see the Brexit crisis reach a conclusion, the political divide may become more acute.
Now, where we are in the cycle is a hot topic
For markets, the current hot topic is where we are in the cycle. Financial markets have been caught out by cyclical changes, both by the global rebound in 2016 and by the slowdown that took place in the second half of last year.
A number of factors contributed to that slowdown, not least policy tightening in the US and the expectation at that time that this would continue. Worries about China added to the mix, as a policy-induced slowdown in domestic demand was exacerbated during 2018 by fears over the deteriorating trade dispute with the US.
The euro area, too, continued to lose momentum, reinforcing the gloom that impacted equity markets in the final few months of last year. After that equity market correction, and the subsequent rebound, we are now in an interesting situation.
Equity markets, it would seem, expect growth to recover. Bond markets, meanwhile, are anticipating a downturn and a possible recession. This does not, however, mean that a market correction for either bonds or equities is inevitable. Indeed, the actions of central banks, in order to offset the downside risks, will likely allow both equities and bonds to be underpinned for now. Markets, though, could be more volatile in response to changing economic data and sentiment.
While there has been a flight to quality, particularly in government bonds, especially in the euro area and the UK, low policy rates and the possibility that central banks including the US Fed may now ease, has allowed high yielding debt to rally, too. As before, when rates were low, the fear is that markets may not be pricing properly for risk.
Three possible outcomes, underpinned by uncertainty
The issue, though, is this: what will follow the recent slowdown? Three broad options are possible: one is stabilisation followed by modest to steady growth; the second is economic weakness and possible recession. In turn, there appears to be little expectation of the third option coming into play – namely, a strong rebound along with a possible rise in inflation. We expect monetary policy accommodation to help stabilise economies. But global growth will slow this year compared with last.
All this uncertainty is also reflected in the UK. Raw politics will determine the Brexit outcome. Still, there are a range of options, including the PM’s “deal” followed by a transition period, no deal, an extension of Article 50 or, perhaps, even a customs union.
Although UK economic data is mixed, the two indicators that suggest the economy is growing strongly are ones that are rarely revised: the employment data and tax revenues. Meanwhile, the GDP figures, which are frequently revised, suggest only modest growth, held back by sluggish investment, as we have outlined previously.
As the markets wait to see how the politics unfolds, expect UK policymakers to retain a bias to ease.
Please remember that when investing your capital is at risk.
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