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FED "Loaded for bear"
of global asset prices will be directly linked to the policy decisions of the Fed and other central banks.
In our view, expansionary monetary policy is the primary reason for current stretched valuations. But until there is a concentrated effort towards “normalization” by a group of central banks, risk appetite will be blindly supported. While many developed market central banks are asking markets to patient, the Fed is coiled, ready to spring into action should inflation pick up. We
anticipate 2.2% GDP growth for the US economy in 2018, and a tightening labour market should push core PCE inflation back to 2.0%.
So far, despite the strong economy, specifically tight labour markets, inflation has perplexingly not appeared. The Fed is also concerned, in relation to the inflation trend, by higher than usual risks linked to the fiscal policy outlook, and an uncertain trade policy, given Trump’s control of policy setting.
Rather than stand idly by, the Fed will be slowly tightening via interest rates and balance sheet roll-off. In addition to the Fed’s paranoia over a pick-up in inflation, though to a lesser extent, is
the desire to regain control of policy tools that have been exhausted in fighting the global financial crisis and resulting stagnation.
Unified Europe will emerge from Spain
It is hard not to view the recent events in Catalonia as a turning point in the European Union experiment. Despite calls from Catalonia and the international community to condemn the brutal police crackdown on the independent referendum, Brussels and most member states have not denounced the violence. There was a hard shift towards integration, as minority voices were structurally suppressed by the majority.
These unnerving events come on the heels of victories by Europe’s national foundations – Macron in France and Merkel in Germany, both of whom are pushing for deeper and faster EU integration. The start of 2017 brought fears of EU demise, as rising political populism suggested an end to EU federalism.
But heading into 2018, Europe is improving economically, despite what may be the end of Merkel’s era. Historically, the EU has been plagued by concerns of fragmentation, with fears that small issues would eventually break up the union. However, we believe that is no longer the case thanks to the powerful trio of Macron, Merkel and Draghi. It is a theory that will have a profound effect on pricing in events such as the Italian elections.
Emerging markets lead the growth charge
Emerging markets (EM) have continued to grow faster than developed markets, with higher returns in 2017. The trend will likely continue in 2018. GDP growth in emerging markets for 2017 is expected to be 4.5% – its highest point since 2015 – versus 2.10% for developed markets. Protectionism was a buzzword for early 2017, as Trump quickly withdrew from the TPP and challenged NAFTA. The rhetoric quickly died down, however, and global trade picked up pace.
The Baltic Dry Index came off its lows, hitting a two-year high on rising demand. The global growth forecast increased to 3.6% for 2018, as the outlook for developed markets has been upgraded. But the story for EM in 2018 will be the further increase in international trading. Following a trend, China has reached 15 free-trade agreements with 23 countries and regions.
Protectionism will continue to take up room in the headlines but real action will be limited, even out of President Trump’s administration. Inter-EM trade will provide some protection against growth deceleration, a stronger USD and policy uncertainty in the US, EU and Japan.
Crypto currencies are the real "Trump trade"
The surprise election of Donald Trump as president of the United States was seen as largely reactionary – less about electing the individual, and more about voicing an opinion on the broken system. The rise of crypto currencies is, in our view, driven by a similar sentiment. The actions of global central banks over the last 40 years – which have accelerated over the last 10 years – have totally eroded people’s confidence in government’s monopoly over money. The Fed created $4 trillion out of thin air as part of $20 trillion globally in balance-sheet expansion.
Government is no longer limited by market-based supply, as real commodities – such as gold and silver – have been known to abuse the trust. We recognize that part of the appreciation of alt-coins is due to speculative trading and revolutionary technologies, but most users are average people who no longer trust the government to protect their wealth. The decentralized aspect of altcoins is allowing Venezuelans and Zimbabweans to escape oppressive and economically careless regimes. While corrections are unavoidable, alt-coins are here to stay.
China grabs the political void
China’s economy is expected to slow slightly in 2018 from 6.6%, due to a prudently managed monetary policy tightening, which is targeting slowing lending through China’s “shadow” financial system.
Yet, empowered by the volatile behavior of President Trump, China has embraced its new role as regional and global leader. In the 1980s, Deng stated that China must “bide its time and hide its light” in foreign policy while the country grew. Judging from the 2017 World Economic Forum in Davos and the Chinese Communist party congress, Xi Jinping and China are ready to step into the light. Heading into 2018, the world needs to work with a confident and economically massive China.
We anticipate direction and pace of market reforms with further veer from the guidance of external nations/supranational organizations and increased internal efforts to entrench China’s hybrid model, which includes politics and economics. In addition, the latest political developments evident at the Party Congress suggest a growing role of centralized planning to avoid cyclical downswings which could undermine the Communist Party’s power privilege.