In a year of political shocks, the unexpected strength of the global economy going into 2017 may be the most enduring surprise for financial markets.
Despite all the electoral upsets – Donald Trump’s U.S. presidential victory plus referendums in Britain and Italy that have pushed both countries into deep uncertainty – economic data are consistently beating forecasts.
Activity seems resistant to the surprises that once might have provoked major market drops, helped by huge sums that many central banks are still pumping into the financial system – and the prospect of government largesse in the United States where the Federal Reserve is reducing its stimulus.
The consensus among forecasters had been too gloomy well before Trump’s election last month electrified markets with the promise of fiscal stimulus via tax cuts and infrastructure spending.
But it’s not just soundings from the United States that have been underestimated amid the political noise, leading Edinburgh-based Standard Life Investments to refer this week to the “quiet strength” of the world economy.
A range of Economic Surprise Indices compiled by Citi have all turned positive this week for the first time since February 2014 – almost three years ago. And a dive into the data shows how widespread the resilience has been.
This is only the 16th time since comparable records began in 2003 that all eight indices – U.S., euro zone, Asia Pacific, Japan, UK, emerging markets, China and G10 nations – have been in positive territory. The euro zone reading is the highest since October 2010.
A surge in optimism among investors in the month since the U.S. election – apart from on the bond and some emerging markets – has been remarkable given the previous consensus on Trump.
Economists at Citi, led by chief global economist Willem Buiter, warned about the risks of global recession for most of this year and in August said a Trump victory could cut world growth by 0.7-0.8 percentage points.
They said this would “easily” push growth below the 2 percent threshold that indicates overall global recession. However, this week, they raised their 2017 global growth outlook to 2.7 percent, up from an estimated 2.5 percent this year.
The Organisation for Economic Cooperation and Development is even more optimistic. Last week it raised its 2017 global growth forecast to 3.3 percent, compared with 2.9 percent this year, as Washington prepares to rev up the U.S. economy.
“The prospect of a U.S. recession in 2017 has diminished,” said Nadege Dufosse, Head of Asset Allocation at asset management firm Candriam, which has around 100 billion euros of assets. “We are therefore overweight on equities, in particular in the U.S. and Japan.”
COME ON, IGNORE THE NOISE
If you’d blinked on the morning of Nov. 9, the day after the U.S. election, you could almost have missed the plunge in stocks, debt yields and the dollar as Asian and European markets reacted to Trump’s win.
U.S. equities quickly recovered, and the S&P 500 .SPX and Dow Jones .DJI haven’t looked back, rocketing to fresh highs. The VIX .VIX measure of stock volatility – Wall Street’s “fear index” – has rarely been lower in its 26-year history.
This is despite the surge in bond yields and a punchy dollar, both of which are tightening global financial conditions even before the Fed starts raising interest rates in earnest – and could yet choke off growth.
In a Reuters poll this week, equity strategists forecast the bull run would continue next year – provided Trump’s plans to stimulate the economy come to pass. His threats to consider imposing new import tariffs and the possibility of a yet stronger dollar limited their enthusiasm.
The policy outlook is fraught too as the shift to government action from central bank money printing gets underway. The transition is unlikely to be totally smooth, yet as JP Morgan points out, the close relationship between policy uncertainty and the VIX index has broken down recently.
If the last few years, particularly 2016, revealed anything, it’s that most political, economic and financial risks around the world have failed to make much of a dent in world markets.
Extreme caution may not be the right response to events like Britain’s vote to leave the European Union, Greece’s brush last year with financial collapse and resulting turmoil in the euro zone, or U.S. government shutdowns due to disputes in Congress.
Mouhammed Choukeir, chief investment officer at wealth manager Kleinwort Benson, told the Reuters Global Investment Outlook Summit last month that investors should not be “too concerned by political noise”.
“If I were to roll the clock back five years and told you there was going to be a Greek crisis, EU crisis, the end of the euro was imminent, that Brexit would happen, that this businessman with radical ideas was going to be president and the U.S. was going to have a shutdown … everybody would be saying we’ll just hoard cash,” said Choukeir, who manages 5.4 billion pounds ($6.71 billion) of assets.
“But that would have been the wrong decision.”
Of course, the last five years have been marked by the most extraordinary central bank stimulus in history, from zero – and even negative – interest rates and quantitative easing bond buying programs running into the trillions of dollars.
Now, the Fed is pulling back but the European Central Bank and Bank of Japan will still be priming financial markets with substantial stimulus next year. The ECB will buy a minimum 780 billion euros of bonds.
The Bank of England in August cut rates to a record low 0.25 percent and resumed its quantitative easing to mitigate any negative effects from the EU departure.
With the formal Brexit process scheduled to begin in March and general elections due in France, Germany and the Netherlands, the European political calendar will again be heavy next year. That central bank support may come in handy.
Source: Reuters (Additional reporting by Mike Dolan; Editing by David Stamp)