Q2 2017 FFTW Quarterly Outlook: Growing Pains

17 Apr 2017


In this paper, we take a look at following topics:

  • Investors are adjusting to the reality that Trump will have difficulty implementing his full economic agenda, or may be pivoting away from some of the ideas expressed during the campaign.
  • The French election and geopolitical risks are also coming into focus and weighing on risk sentiment.
  • We see the key risk in Europe as lying not in France, but in Italy, with its combination of dysfunctional politics, weak banks, poor macro performance and high debt load.
  • We are skeptical that United Kingdom economy can remain immune to the impact of Brexit, and see clear risks of a slowdown in demand that leads to further monetary easing even as inflation pressures rise.

Growing pains

How quickly the market mood can sour. With the end of President Trump’s first 100 days in office now in sight, investors are decidedly underwhelmed with the administration’s accomplishments to date and prospects for transformative policies going forward. Other than steps towards reducing regulation, economic policy accomplishments have been limited, particularly relative to expectations immediately following the election. Importantly, the ongoing negotiations to replace the Affordable Care Act have pushed back the timeline for tax reform until the fourth quarter at the earliest, and the contours of future tax measures have actually become less clear over time. At the same time, the negative labor force impact of the administration’s deportation and immigration policies may weigh on trend growth in the longer run, an outcome that is directly counter to a “Make America Great Again” economic agenda.

To be fair, the administration’s growing pains have had some positive aspects, particularly as they have led to restraint in  a few key policy areas. As one example, if health care reform has proven complicated, so has trade policy. We have been encouraged that cooler heads within the administration  have thus far prevailed over the protectionist leanings of  the President and some key advisors. Still, this remains a  key risk we are monitoring, and we remain concerned that  the administration may eventually turn to tariffs if it faces  pressure from its political base to deliver on its campaign  pledge to resuscitate manufacturing employment.

Markets have had more than just the growing pains of a new  administration to contend with. Even as investor confidence in the global growth outlook remains relatively high, data  in hand point to a weak first quarter in the United States.  Furthermore, uncertainty regarding the outcome of the French election has risen in recent weeks, and the Trump  administration faces early geopolitical tests on the Korean  Peninsula, and in its relations with Russia regarding the  Assad regime in Syria.

Against this uncertain backdrop, it is not surprising that most major stock markets have traded sideways to lower in recent  weeks and developed market sovereign bond yields have  declined. The question is, where do we go from here? As I flagged in our prior quarterly, we always expected tax reform to be a messy and drawn out process, and our outlook for  somewhat firmer growth this year was based as much on  an improved outlook for capital expenditure as it was on  anticipated fiscal stimulus. Risks to our growth outlook are relatively balanced – fiscal stimulus could still surprise to the upside, and we may be under-appreciating the potency of the animal spirits unleashed since the election. On the other hand, firming gasoline prices and inflation, along with somewhat tighter lending standards on consumer loans,  could weigh on household spending this year.


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