Looking back on 2016, I can’t help but note that my commentary for the first quarter riffed on a French expression that loosely translates as, “The more things change, the more they stay the same”. At that time, global growth remained sluggish, global fiscal policy remained constrained by high levels of debt or political paralysis, and monetary policy in much of the developed world was viewed as struggling to provide sufficient support to growth and inflation. The financial crisis was fading further into the rear view mirror, but a deep-rooted pessimism on global growth prospects in a heavily-indebted world prevailed.
The current mood among investors could hardly be more different. The election of Donald Trump as US president, coupled with a cyclical upswing in global growth, has revived animal spirits and buoyed expectations that at least in the United States, the low growth and low interest rate narrative of the post-crisis period may be drawing to an end. Much of this optimism stems from prospects for fiscal and regulatory easing. For the time being, investors appear to have put aside concerns about the incoming administration’s protectionist leanings and an isolationism that could upend the international order. We remain concerned about these risks, and view them as an important part of the market narrative in the year ahead. We also see the process of fiscal reform – let alone fiscal stimulus – as messy and drawn out, the Republicans’ filibuster-proof majority notwithstanding. Still, we recognize that perception of a more business-friendly operating environment and prospects for lower household and corporate taxes could underpin stronger spending and investment, leading to a pickup in growth in the year ahead. But the $100,000 question is whether the new administration’s policies can meaningfully boost the economy’s potential in the years ahead. Without this, stimulus could stoke inflation and lead the Federal Reserve (Fed) to bring forward interest rate increases and the day of reckoning for balance sheet runoff. A move away from gradual policy tightening may be a story for 2018, but markets won’t wait until then to discount the risk. The European Central Bank’s (ECB) conditional retreat from quantitative easing (QE) also bears close monitoring; should the Governing Council mark up the Eurozone’s growth and inflation outlook, pressure could build later this year for another reduction in the pace of asset purchases.
Finally, the populist tide that ushers Trump into the White House (and the UK eventually out of the European Union) has yet to ebb. Investors largely shrugged off stalled constitutional reform and Prime Minster Renzi’s resignation in Italy. A similar complacency regarding upcoming elections in France and the Netherlands (and possibly in Italy as well) is unwarranted, as markets will view the results as referenda on remaining in the Eurozone.
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