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12 FEBRUARY 2018
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Azad Zangana, Senior Economist & Strategist - Schroders
Global Markets Review & Outlook
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2
§ Global overview: From goldilocks to reflation
§ Markets: Is there room for equities to rise further?
§ US: Animal spirits return
§ Europe: How long can the ECB keep policy loose?
§ Brexit: Deal or no deal?
§ Emerging markets: In the midst of a cyclical upswing
Source: Schroders Economics Group.
Latest economic themes and questions
OUTLOOK FOR THE GLOBAL ECONOMY IN 2018
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Global OverviewFrom goldilocks to reflation
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4
Source: Thomson Datastream, Schroders Economics Group. 5 February 2018.
Leading indicators point to a continued acceleration for the G7
GLOBAL GROWTH IS SURGING ONCE AGAIN
-20
-15
-10
-5
0
5
10
15
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
G7 Industr ial product ion, % y/y Global act ivity indicator, 3mMA (normalised)
%, y/y
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5
Source: Thomson Datastream, Schroders Economics Group. 5 February 2018.
Producer prices in the G7 and China suggest higher CPI inflation to follow
INFLATION PRESSURES ARE ALSO BUILDING
-10
-8
-6
-4
-2
0
2
4
6
8
10
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
G7 CPI G7 PPI China PPI
%, y/y
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6
Unemployment has recovered since 2007…
…but private sector wage growth still sluggish for most
Labour market dynamics: economies are transitioning into the expansion phase
Source: Thomson Datastream, Schroders Economics Group. 7 February 2018.
UNEMPLOYMENT RATES CONTINUE TO FALL AS WAGES RECOVER
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7
Source: Thomson Datastream, Schroders Economics Group. 1 February 2018.
Schroders interest rates forecast
SLOW AND GRADUAL RISE IN POLICY RATES MOST LIKELY
-1
0
1
2
3
4
5
6
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Fed BoE ECB Schroders' forecast OIS forward curve
Main policy interest rate (%)
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USAnimal spirits return
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9
Confidence has surged in the US and capex is likely to follow
Source: Thomson Datastream, Schroders Economics Group. 5 February 2018.
RETURN OF ANIMAL SPIRITS IN THE US
80
85
90
95
100
105
110
20
40
60
80
100
120
140
03 05 07 09 11 13 15 17RecessionUS consumer conf idenceNFIB small business opt imism,rhs
-20
0
20
40
60
80
100
120
-20
-15
-10
-5
0
5
10
15
05 07 09 11 13 15 17
US non-res private f ixed investment growth
CEO economic out look survey, 1Q lag, rhs
%, y/y
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10
Key changes in Tax Cuts and Jobs Act (-$1.46tn)Business taxes (-$654bn)§ Corporation tax reduced from 35% to 21% and repeal corporate Alternative Minimum Tax (-
$1.4tn)§ Reduce taxes on pass-through business income (-$415bn)§ Limits on business interest deductibility from fully deductible to 30% of business’ adjusted taxable
income until the end of 2021 and excluding depreciation after 2022 ($253bn)Individual taxes (-$1.13tn) Tax rates go from 10%, 15%, 25%, 28%, 33%, 35%, 39.6% to 10%,12%, 22%, 24%, 32%, 35%, 37%, ends 2025 (-$1.2tn)§ Individual Alternative Minimum Tax (AMT) exemption increased, ends 2025 (-$637bn) § Increase the standard deduction, ends 2025 (-$720bn)International tax reform ($324bn)§ Repatriation of profits; 15.5.% tax on liquid investments and other untaxed foreign earnings at 8%.
Future foreign earnings not taxed ($339bn)Impact§ Oxford Economics estimate the package will boost US GDP growth by 0.4 percentage points in
2018 (adding 0.3 pp to consumption and 1.4 pp to business investment)
*() is revenue impact for fiscal year 2018-27 from Joint Committee on Taxation (JCT) Source: Schroders Economics Group, JCT, 20 December 2017
The US “just passed the biggest in history Tax Cut and Reform Bill”, President Trump
TAX CUTS FOR 2018
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Source: Thomson Datastream, Schroders Economics Group. 5 February 2018.
Profit share suggests the expansion phase of the business cycle has further to run
COULD THE US MOVE FROM EXPANSION TO SLOWDOWN?
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EuropeHow long can the ECB keep policy loose?
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Source: Thomson Datastream, Eurostat, Schroders Economics Group. 8 December 2017.
Contributions to GDP growth
DOMESTIC DEMAND RECOVERY HAS BEEN KEY
-6
-4
-2
0
2
4
6
97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17
Contr ibut ions to GDP growth (%, y/y)
Consumption Investment Government Net trade Inventories GDP
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Source: Thomson Datastream, Markit, Belgian National Bank, Eurostat, Schroders Economics Group. 5 February 2018.
Eurozone GDP vs. BNB survey & PMIs
SURVEYS SUGGEST FURTHER UPSIDE RISKS TO GDP GROWTH
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“…an ample degree of monetary accommodation remains necessary to secure a sustained return of inflation rates towards levels that are below but close to 2 percent...”
“…the (QE) programme has done what could realistically be expected of it…there is no reason whatsoever to continue the programme…I feel that we need to be clear about this.”
“We are now at the point where we are starting to see wages ticking up in a very tentative way, also core inflation ticking up in a very limited way in the eurozone, because we might be exactly at this tipping point where the Philips curve is steepening”
Source: Schroders Economics Group 1 February 2018.
Benoît Coeuré, European Central Bank Executive Board
Member Speaking at a Davos event, 26 January 2018
Klaas Knot, president of NDB & ECB’s governing council
member Speaking in an interview on the TV talk show
Buitenhof, 28 January 2018.
Peter Praet, ECB chief economist
Speech given at the Council of the European Union, Brussels, 29 January 2018.
A SPLIT AMONGST THE ECB’S GOVERNING COUNCIL HAS EMERGED
A dove, a hawk, and a canary?
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Source: Thomson Datastream, Eurostat, Schroders Economics Group. Updated 27 November 2017. Please see the forecast risk warning on the important information slide.
Energy base effects have caused inflation to rise, but only temporarily
INFLATION LIKELY TO RISE THROUGH 2018
-1.5%
-1.0%
-0.5%
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
2012 2013 2014 2015 2016 2017 2018 2019
Y/Y
Core Food incl. alcohol & tobacco Energy Headline
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BrexitDeal or no deal?
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18Source: Thomson Datastream, Schroders Economics Group. 23 January 2018.
Energy base effects have caused inflation to rise, but only temporarily
THE UK HAS SLIPPED FROM TOP OF THE G7 GROWTH LEAGUE TO BOTTOM
-8
-6
-4
-2
0
2
4
6
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Real GDP growth, % y/y
G7 range UK
UK Brexit referendum
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§ The 8 December agreement on citizens’ rights, Northern Ireland and the divorce bill paves the way to begin phase II of negotiations, which will include a framework for trade.
§ Northern Ireland is not fully resolved yet, but a commitment to maintain the 1998 peace accord could lead to a softer Brexit, possibly EEA membership.
§ The UK still believes it can get a bespoke deal, with a full withdrawal from the single market and separate trade deal for tariff free access.
§ Some restrictions on migration are politically necessary for the UK, along with repatriation of power from the ECJ.
§ Minimum 2-year transitional period is very likely, with ongoing discussions over finer details.
A broad agreement reached on citizens’ rights, Northern Ireland and the divorce bill
Source: Schroders Economics Group. 2 February 2018.
BREXIT NEGOTIATIONS TO MOVE TO PHASE II
1.06
1.11
1.16
1.21
1.26
1.31
1.36
1.41
1.46
1.20
1.25
1.30
1.35
1.40
1.45
1.50
1.55
1.60
Jan 15 Jul 15 Jan 16 Jul 16 Jan 17 Jul 17 Jan 18
GBP/USD GBP/EUR
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Emerging MarketsIn the midst of a cyclical upswing
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Source: Thomson Datastream, Markit, Schroders Economics Group, 5 February 2018.
Developed markets vs emerging markets PMIs
EMERGING MARKETS ARE ENJOYING A CYCLICAL UPSWING
35
40
45
50
55
60
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Balance
Developed markets Emerging markets
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22
Source: Thomson Datastream, Schroders Economics Group. 1 February 2018.
Trade weighted USD vs. relative MSCI EM performance
WEAKER USD PRESENTS UPSIDE FOR EM ASSETS RISK ASSETS
70
80
90
100
110
120
1300.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1.0
1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017
MSCI EM vs World ($) USD TWI, rhs (inverted)
Ratio Index
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23Source: Thomson Datastream, Schroders Economics Group, 16 January 2018
EM currencies have already fallen significantly
EMERGING MARKETS AND THE FED
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.66065707580859095
100105110
12 13 14 15 16 17 18JPM EM FX index Fed Funds rate, rhs (inverted)
%Index0.0
0.5
1.0
1.5
2.06065707580859095
100105110
12 13 14 15 16 17 18JPM EM FX index US 2 year yield, rhs (inverted)
%Index
Taper Tantrum
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24Source: Google images (rights free), Wikimedia Commons
Election year!
LOCAL POLITICS TO CAUSE SOME VOLATILITY
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
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MarketsStretched valuations
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Data based on MSCI US index. Source: Thomson Datastream, Schroders Economics Group. 5 February 2018.
US equity PE ratio suggests valuations are stretched
ARE EQUITIES UNDER THREAT?
0
5
10
15
20
25
30
35
50 54 58 62 66 70 74 78 82 86 90 94 98 02 06 10 14 18
MSCI-US reported price-earnings ratio
Equities overvalued
Equities undervalued
1 SD=22
-1 SD=10.9
Avg. 16.4
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Global equities calculated by Datastream. Source: Thomson Datastream, Schroders Economics Group. 5 February 2018.
Earnings growth has been the key driver of returns
EQUITIES APPEAR TO BE WELL SUPPORTED BY GROWTH
-80
-60
-40
-20
0
20
40
60
80
100
120
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Rating (change in PE ratio) EPS growth Change in global equity prices
Y/Y, %
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28
Thomson Datastream, Schroders Economics Group. 1 February 2018.
Little term and inflation premium built into US Treasury bonds
GOVERNMENT BOND YIELDS SHOULD BE HIGHER
0
2
4
6
8
10
12
14
16
'73 '75 '77 '79 '81 '83 '85 '87 '89 '91 '93 '95 '97 '99 '01 '03 '05 '07 '09 '11 '13 '15 '17
%
US S&P500 dividend yield US 10yr treasury benchmark yield to maturity
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29
Size of central banks’ balance sheets
Source: Thomson Datastream, Schroders Economics Group, 19 January 2018. Please see the forecast risk warning on the important information slide.
QE LIKELY TO BE UNWOUND VERY VERY SLOWLY
0
5
10
15
20
25
05 06 07 08 09 10 11 12 13 14 15 16 17 18 19Eurozone Japan Switzerland China US UK
Value of assets in central banks' balance sheets (Trillions of USD)
0%
20%
40%
60%
80%
100%
120%
140%
0%
10%
20%
30%
40%
50%
60%
70%
05 06 07 08 09 10 11 12 13 14 15 16 17 18 19
% of GDP
Forecast US UK Eurozone Japan, rhs
% of GDP
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30
§ As the global economy moves from goldilocks to expansion, higher interest rates will challenge
further gains in risk assets
§ However, strong growth and slowly rising inflation can keep the rally going
§ There is room for upside surprises in most regions
§ The fiscal stimulus package in the US could be very powerful for growth
§ The ECB is likely to end QE in 2018 and start hikes in 2019
§ Brexit details have to be finalised by the Autumn, expect more volatility
§ Emerging markets look healthy, but beware of political risk in 2018
Source: Schroders Economics Group.
Key questions
STRONG GROWTH TO CONTINUE TO SUPPORT RISK ASSETS
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Thank you