If it’s so perfect, why are we so nervous?

10 Jan 2018

  • A solid global growth outlook leaves us cautiously optimistic on the outlook for risk assets, but volatility – and rates – should rise over the course of the year.
  • We remain focused on two key risks going forward: a possible pickup in inflation, and changing sovereign bond supply dynamics resulting from both a wider US deficit and changes to central bank balance sheet policy.

At the start of a new year, I often find it useful to look back on our commentary from 12 months earlier. Reviewing that commentary, what strikes me is how little the political risks that we and others had highlighted mattered for markets in the final analysis. President Trump certainly dominated the headlines last year, but some of the risk scenarios that had investors wringing their hands, for example a possible trade war between the United States and its major trading partners, never materialized. Across the Atlantic, the populist wave that set the United Kingdom on a course for Brexit dissipated against the breakwater of the Eurozone, leaving Euro-skeptic parties largely out in the cold. Instead, what mattered most for markets in 2017 was the sustained pickup in global growth, supported by still-easy monetary policy from major central banks who signaled that future reductions in accommodation would be measured. Indeed, the number of major economies experiencing positive quarterly growth in 2017 has not been seen since the early days of this expansion. Throw US fiscal stimulus into the mix, add a pinch of tax reform, and it is not at all hard to see the ingredients of a powerful energy shake for risk assets.

For the time being, the reflation trade is back, with most economists calling for a further pickup in global growth and stable-to-rising inflation in major economies. It is easy to focus on the United States given fiscal stimulus that would make the staunchest supply-sider blush and comes on the heels of a pick-up in growth. But we should not forget that perhaps the biggest growth surprise has been the Eurozone, where if anything, survey data suggest that the recovery is gathering momentum. In addition, the recovery there extends beyond core economies, and has not simply been driven by stronger global growth; domestic demand accounts almost entirely for the recent pace of Eurozone GDP growth.

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