Strat Doc 1Q18 – Global Macroeconomics

25 January 2018


by Blake Allen

This section touches briefly upon the economic views that underly our Asset Allocation and Strategy.

The global economic outlook for 2018 should, in our view, largely reflect the continuity of trends that gained traction during the prior year. In particular, global growth, and consumer and business sentiment, are expected to be even more buoyant: note that we have again raised our global growth forecasts for CY18. Thus, our basic approach is to evaluate the risks associated with a period of sustained above-trend growth, such as meaningful policy tightening, rather than the risks attached to the possibility of growth merely wilting.

As slack capacity in global labour markets is increasingly mopped up, core inflation should finally start to respond. This development is far more advanced in the US than it is in other regions. Europe, in particular, could continue to grow for a number of years before reaching similar capacity constraints. This development will be reinforced by the lack of deflationary drafts from the commodity price slump of 2015 and early 2016, and the strong US dollar seen in 2014. Indeed these variables are now exerting an inflationary effect. Nevertheless, we think the uptick will remain very modest, with US core PCE inflation only just reaching the Fed’s 2% target, and probably only by late 2019.

Global monetary policy is broadly reflecting the above developments. Although inflation prints have remained well below central banks’ targets, it must be noted that central banks set policy rates with reference to their expectations of future inflation. The Fed expects to hike rates three times during 2018, consistent with their expectation of rising core inflation. The European Central Bank (ECB) is however about three years behind the Fed’s trajectory, consistent with the European economy’s position vis-a-vis that of the US. As noted in previous reports, this “normalisation” of almost a decade of “abnormal monetary policy” is perhaps the most important and complex theme characterising the global economy at present.

There is a risk that interest-rate hikes over the next two years, due either to an inflation overshoot or to policy error, could hamper global growth and asset prices. The risk of policy error is partly connected to the now much more leveraged global economy, for which relatively small rate hikes have a far larger income statement effect. Although we monitor this risk, it is not our base-case scenario. Further, even if rate hikes do not hamper growth, there is a risk that they will weigh on both of the classical pillars of a diversified portfolio, these being equity and government bonds. Our asset price outlook, discussed in more detail below, has baked the latter scenario into our base-case forecasts, reflecting rising bond yields and compressing PE multiples.

The shift to pro-business administrations in both France and the US, seen during 2017, should continue to result in encouraging shifts in government policy over the coming years. Deregulation and the passing of the US tax bill are important recent developments. Going forward, a potential infrastructure spending plan could provide further fiscal thrust to US GDP. These developments in the US, likely to widen the deficit, and therefore the supply of government bonds, reinforce the effects of rising inflation on US interest rates.

The global economy remains in a period of extremely high liquidity. As much as other economic fundamentals, liquidity drives asset prices, and is indeed one of the reasons we have seen bull markets simultaneously in asset classes that are typically inversely correlated. The end of quantitative easing (QE) in the US, and gradually rising rates, do suggest an environment of less liquidity. Nevertheless, healthy credit extension to the private sector, and monetary policy that is still very loose in absolute terms, should see liquidity levels remain extremely high through the end of 2018 and well into 2019.

On the domestic front, we think SA headline inflation continues to face downward pressure from a combination of a stronger rand and the weak consumer environment. We expect that inflation will trough at 4.0% during the first half of the year before gradually increasing again, averaging CPI of 5.1% for 2018. We expect that improving fundamentals on the political front will take a while to work through the system, although an uptick in consumer sentiment might give a boost to the economic growth rates for 2018 towards 1.1% (2017: 0.7%).

The South African Reserve Bank (SARB) is naturally reluctant to cut interest rates and will likely use the global tightening of monetary policies, the drought (and oil prices) and the possible downgrade by Moody’s as reasons not to cut rates. We expect that, faced with inflation at 4% and a weak consumer they will, however, be pushed into reluctantly cutting interest rates twice by 0.25% each time during the first half of the year.

Figure 1: Global macroeconomic forecasts




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