Listening to recent central bank speeches, one can’t help but get a sense of summer cheer. Risks to the global economy, which had been skewed to the downside, now appear broadly balanced. The shift in the macroeconomic outlook has been so great that policy normalisation is on the horizon, not just in the US but elsewhere. That’s a good thing, right? Judging from the reaction in equity markets, maybe not. If the punchbowl is taken away, what appears on the face of it to be good news for the macroeconomy, may turn out to be bad news for investors. “As one door shuts, another one closes”, or so my grandfather used to say. But that is such a ‘glass half empty’ attitude. As our clients are only too aware, at Fathom we always look for the positives in everything. And in that respect it is worth noting that, over the past year and a half, regions that were thought to pose the greatest threat to the global economic recovery have actually been a source of strength.
Step back in time 18 months and, according to a Bank of America Merrill Lynch survey, China was the overriding concern. Following a poorly executed currency devaluation and see-sawing stock markets, its economy was teetering on the brink. Or so it appeared. The country’s economic mandarins, previously viewed as omnipotent, were suddenly fallible. Seemingly cornered, the authorities in Beijing returned to a tried-and-tested trick. Credit flowed freely once again and public investment was ramped up, helping to lift global metals prices, and offering a boost to previously bruised commodity currencies such as the Brazilian real and the South African rand.
With the risk of a Chinese hard landing put to one side, for the time being at least, investor concerns focused instead on the upcoming US presidential election. The surprise Republican nominee, a political novice with a mishmash of unorthodox policy proposals, was seen as the global economy’s key downside risk. A Donald Trump victory was expected to destabilise business confidence, and weaken economic growth. However, within hours of the result being declared, market participants did a one-eighty. Concerns about unpredictability and protectionism were tossed to one side, as they instead focused on his pledges to cut taxes and boost infrastructure spending. Equity markets jumped on expectations that the US would drive global reflation.
As 2016 became 2017, anxious money managers were fretting about the future of the euro area: that flawed currency union made up of unemployed young people and angry old ones. It was hard not to be pessimistic. Italian bank balance sheets were stuffed with NPLs like a toxic financial ravioli. Meanwhile, a Marine Le Pen presidency, and with it Frexit, could not be ruled out. For some, the disintegration of the euro area was just around the corner. However, in the first quarter, while investors had been predicting its demise, the euro area economy was quietly expanding at a faster pace than either the UK or the US. The French presidential election added yet more egg to the pollster’s face, with Emmanuel Macron winning by an even larger margin than expected. With the possibility of a new Franco-German partnership on the horizon, long-Europe was back in fashion.
Three of the biggest supposed downside risks have ended up supporting bullish investor sentiment. But there is always something new to worry about. Or is there? With the global economy humming along nicely, investors have recycled an old one: China. Aware of the risks of an unprecedented credit binge, policymakers are apparently keen to rein in borrowing. If poorly executed, that could lead to a sharp slowdown in economic growth, with significant negative spillovers.
During recent internal discussions about the key issues facing the global economy, we have come to the conclusion that a tightening-induced slowdown in China has replaced a potential reversal of globalisation as the main downside risk. Whether China is able once again to thwart the ‘Negative Nancys’, and boost world economic activity, remains to be seen. We look forward to sharing our own views with clients in the coming weeks during presentations of our Global Economic and Markets Outlook for 2017 Q3.