A Positive Message from Washington
The annual meetings of the International Monetary Fund (IMF) and World Bank were taking place, attended by the world's leading central bankers and finance ministers. In addition, there were thousands from the banking and financial industry who were attending meetings of their own or with policy officials. I was there, speaking at the Institute for International Finance’s annual conference as well as at a number of roundtable debates, while attending other events such as the Bretton Woods Committee. These gatherings are a good place to measure the pulse of the world economy.
The mood was the most positive I can recall since the annual meetings in 2007. It also represents a significant change from recent years. Two years ago when these meetings took place in Lima, pessimism prevailed. Then last year, in Washington, there was caution as populism and politics dominated every debate.
One of a number of key factors we take into account in our investment allocation is the global outlook. Throughout this year we have taken a positive view of global growth and it has been surprising how cautious consensus thinking has been. Now, it seems, our upbeat assessment about growth is becoming more widespread.
Highlighting the change, was the IMF’s upward revision to its forecasts for global growth. Post crisis the tendency has been for forecasts to be revised down. After 3.2% last year, global growth is expected to be 3.6% this and 3.7% next. The IMF talked of stronger growth driven by rising trade, investment and production. It is a cyclical and synchronised upturn. Only a handful of countries across the globe are not expected to grow this year.
IMF Macroeconomic Forecasts
Source: International Monetary Fund (IMF), World Economic Outlook (October 2017). Year on year increases are shown.
The top line shows global growth, the other data relates to 'Advanced Economies', who are sometimes referred to as 'western economies'.
Consumption, Government (Govt) Spending and Investment represent the key domestic components of the overall increase in Advanced economies' GDP growth - there is also trade but that is not shown here. These highlight the stronger contribution from investment.
Based on the sentiment in Washington, these forecasts may prove too low. Corporate earnings are rising and there is increased employment across many countries.
There was an upbeat message from many American speakers, led by Treasury Secretary Mnuchin, who talked enthusiastically of tax cuts helping growth and of firms with cash to invest.
The message from Asia was of recovering exports and trade. Unlike last year, when there was talk of a hard landing in China, there is now optimism about the pace of growth there, helped by stronger domestic demand. Meanwhile, many emerging economies expect China’s Belt Road Initiative and increased spending on infrastructure to provide a huge boost. In my view, the Belt Road and the Fourth Industrial Revolution will be strong drivers of future growth.
Even the Japanese and Europeans were talking of how cheap money was now contributing to solid recovery. When it came to the topic of Brexit, however, there was a divergence, with pessimism among those who are picking up a negative message from observing UK politics and reading the international English press versus optimism from those who are closer to the action, investing in the UK, and who expect a deal to be agreed with the EU.
Reasons to be Cautious
Despite global optimism, there were concerns in Washington. The IMF could not bring themselves to be too optimistic - stressing that medium-term economic risks are tilted to the downside, citing inflation below target and that potential growth is weak in many countries. While this may be so, the reality is that as growth continues to recover, this provides a window of opportunity to tackle global challenges too.
Geopolitics figured prominently. There was concern about President Trump’s approach to the North American Free Trade Agreement (NAFTA), North Korea and Iran. Markets may soon be forced to price more for these risks.
Debt levels also remain high. Yet the big debate was about how sustainable this growth will be when monetary policy tightens. We have had almost a decade of unconventional monetary policies in the west. This has worked by boosting asset prices, and while this has added to inequality it is now generating growth. The consensus in Washington was that these unconventional measures might also take a decade to unwind.
Another economic concern is the uncertainty that exists about what is driving a number of key variables such as wages, inflation and productivity. All of these matter for growth and policy.
The challenge is for more people across the world to share in success. This requires not just solid jobs growth but a recovery in wages too. While technology and globalisation have restrained wage growth, this could now change because of tightening labour markets in the west.
Inflation will be key
Although few think inflation will be a problem, there was the occasional reminder that inflation came out of nowhere in the 1970s. While central bankers may have been unconventional they wanted everyone in Washington to know that they are still conservative. If inflation threatens, they would act to restrain it.
Market valuations remain a concern for many, but no-one seemed to be predicting any imminent change in current sentiment. Across financial markets, volatility is low, markets are not pricing for risk and the predictability of monetary policy has reduced the need to hold liquidity. The challenge will come when more countries start to tighten in unison.
In my view, policy post-crisis was characterised by the three S’s: it was sizeable, synchronised and successful. Now, central bankers will need to focus on a different set of S’s: sequencing, scale and shocks. They need to sequence properly, raising rates and withdrawing from quantitative easing. The scale and pace of tightening also needs to be very gradual. They must also avoid shocking the markets.
The outlook depends upon the interaction between the fundamentals, policy and confidence. As the economic outlook and confidence improves, policy becomes the main focus.