7 questions for ‘17
In my last post I reflected on the year that we’ve had and how it sets us up for the coming year. To keep us focused, we decided that it would be appropriate to distil our outlook for 2017 into seven key questions that we’ve asking ourselves this year...
- Does the US face a recession in 2017?
In terms of the US economy, some of the drags on growth from earlier in the year are now fading, which, alongside resilient labour market and consumer spending is boosting growth prospects going into 2017. If Trump follows through on his tax and spending plans it raises the risk that the US economy grows too quickly, rather than too slowly. However, if that happens alongside accelerating rate hikes, markets could be well on their way to anticipating the next recession (which we expect to come in 2019) by year end.
- Is Trump good or bad for US equities?
The surprise election result has been greeted positively by US equity markets. So far the pro-business agenda of Trump, prospects of deregulation and more spending, has outweighed concerns around protectionism and uncertain foreign policy. Significant increases in government spending or tax cuts could boost earnings growth into double-digit territory, squeezing equity prices significantly higher, even if only temporarily. But any moves by Trump that harm global trade or cause geopolitical tensions will likely harm equities.
- Brexit means Brexit, but what does it mean for the UK economy and interest rates?
Post-referendum, the UK economy has been helped by a buoyant labour market and low inflation. However, economic surveys suggest firms are cautious about hiring plans, and downbeat about business investment intentions. Much will hinge on how the negotiations with the EU take shape, and whether transitional arrangements can avoid a ‘cliff effect’. Despite the coming rise in inflation overshooting the 2% target, we don’t think the Bank of England will feel comfortable raising interest rates. They will also want to keep their powder dry, so we don’t expect any cuts to interest rates in 2017.
- What does Trump mean for the US dollar and interest rates?
The US dollar has been on a charge in late 2016 as the market looks to higher US interest rates and possibly a big-spending Trump administration. With the US likely to be the fastest-growing developed economy in 2017 and potential tax changes to encourage US companies to bring overseas earnings home, there is a risk that the US dollar keeps surging. But beware - anything that knocks confidence in US growth and ongoing interest rate hikes could cause a sharp pullback in the dollar.
- Is Europe revolting?
Europe faces a number of elections over the next twelve months. Markets are most focused on the risk of a victory in the French presidential election by the far right Front National candidate Marine Le Pen. Thanks to large levels of European government debt and the inter-connected nature of European financial arrangements, politics really matters to markets. Fortunately, balancing this political risk is the fact that the European Central Bank has been buying government debt to prevent low inflation morphing into outright deflation. We are positive on euro area growth compared to consensus, helped by the ECB’s policies, but politics will remain firmly on our risk radar.
- Emerging markets – friend or foe?
Emerging markets will be facing a headwind as the US starts to raise interest rates, making it harder for emerging markets to attract investors’ funds. But it’s not all bad news. Commodity prices have bottomed after falling since 2011 which should give a boost to commodity-intensive Latin America. The global manufacturing cycle is also improving which should benefit manufacturing-intensive Asia. Growth is expected to improve in Brazil and Argentina after severe slowdowns. In contrast, growth is expected to slow in India, given the demonetization programme and a weak underlying investment cycle.
One key risk for 2017 is a significantly weaker Chinese currency driven by capital leaving the country. Our base case is that the Chinese will manage a 5% real currency fall at the cost of lower foreign currency reserves and tighter capital controls, particularly given the Communist Party’s power transition in late 2017. We do not expect a sharp slowdown in growth. However, the risk of a faster devaluation is not immaterial and, as we saw in 2016, would likely lead to weaker global equity markets.