11th January 2017
2016 will be long remembered as a year of great change both politically and potentially economically. Many fundamental questions have arisen, the answers to which will shape the global economy for years to come: Will Trump move the US forward (or backwards)? Can the UK implement a clear and manageable plan for Brexit? With several key elections in Europe will populist ideals continue to win out over the neoliberal elite? Perhaps most importantly, can renewed optimism over economic conditions and inflation finally find real justification, or is this merely another false dawn? 2017 is set to be a year of discovery and change.
Politically, change is palpable on both side of the Atlantic. However in spite of the posturing, we are yet to see clear evidence of sustained change on the economic front. The major challenge will be successfully weaning the global financial system off 8 years of Quantitative Easing/Zero Interest Rate Policy (ZIRP) and allowing a broader fiscal push to lead economic conditions forward. All of this of course without creating a stagflationary quagmire. At national treasury level as well as in the central banking sphere, the key players need to find a way to balance the colossal debt overhang that has been building since 2008. I.e how to facilitate more spending without causing a significant increase in rates. Such an increase would create considerable instability given we are now living through the most overleveraged economic conditions the world has ever seen. Zero rates and QE have facilitated both a substantial rise in asset prices whilst allowing for the explosion of debt levels. This balancing act will be the main issue for the financial markets as we move from a monetarily lead expansion to a fiscally led one. Important changes at the head of the Federal Reserve at the end of the year will potentially represent the most important change to economic thinking and implementation since the early 1980’s. There are many issues at play alongside the interest rate story which will have a big impact on the global economy. The hefty rise in the dollar, or we should say increase in the reserve currency of the world, is as big an issue as the rise in interest rates. US monetary policy and in particular QE, expanded the availability of US dollars globally which the world gratefully accepted. To turn up the heat (stronger dollar) on a fragile world still reliant on US dollar funding (now mostly for corporate use) will be extremely challenging. Any future policy action that propels the dollar further will potentially undermine any potential positive economic impact a renewed fiscal expansion might bring.
The ongoing challenges for the Chinese economy and their increasing diseconomies of scale (declining return on investment) will have a major bearing on the global economy. One suspects 2017 will be much like 2016 in China as it continues to try and steer the ship away from continuous stimulus packages. As these challenges become more extreme one should expect the Communist party to increase their nationalistic rhetoric. Trump looks to be making himself a very easy target. The significant issues surrounding the upcoming fiscal challenges of growing entitlement payments in the west make clear the scale of the challenge. Change was needed for sure, but do populist movements possess the policies that will achieve their stated (unstated) goals without pulling the rug from under the whole system? 2017 will be the start of this discovery process.
From a markets perspective, one needs to be increasingly vigilant. Excessive exuberance can quickly turn to disillusionment and even despair. As with any significant turning points in history – either politically or economically – the signals are difficult to read. This transition is a particularly challenging one given the precarious position in which many economies and financial markets find themselves. A little surprisingly the Fed (and the other major central banks) have managed the last number of years with an impressive degree of control over market conditions. As central banks’ ability to influence the economic and market outcomes fades, the risk of market shocks and surprises intensifies. As with 2016 Rubrics Asset Management will be planning for another year of challenges and substantial opportunities.
By Steven O’Hanlon