As shock waves and fears over rise of populism subside, markets look likely to hold steady course in new year
THE rise of populism in the major economies of the western world throughout 2016 sent shock waves through global markets. As 2017 approached, there was a growing expectation that the election of President Donald Trump and the reality of Brexit would result in such a movement gathering momentum. However, in the end, such fears have largely failed to materialise in 2017. Populism has at times reared its head but hasn’t had the effect that was initially feared.
Elections in France and the Netherlands early in the year were watched closely by the rest of Europe, as both presented the prospect of extreme leadership candidates gaining power and influence. Much to the relief of markets, Marine Le Pen and Geert Wilders were defeated in their respective elections and, elsewhere in Europe, the German and Austrian electorate showed modest support for the far right.
With political fears receding into the background somewhat, investors have turned their attention to more conventional macro-economic developments. In this respect, 2017 has been a year of synchronised re-acceleration of global growth and subsequently a continued move towards the normalisation of monetary policies.
Most notably, eurozone growth is at its strongest level since 2007 and forward-looking indicators remain positive; elsewhere on the global spectrum, unemployment rates continue to fall.
The US Federal Reserve continued to lead the major economies in their quest to tighten monetary policies. Having hiked rates three times in a year it has also started the process of reducing its balance sheet, currently much expanded as a legacy of the Fed’s QE strategy.
Closer to home, last month the Bank of England boldly moved to increase interest rates for the first time in a decade. The ECB even took its first modest steps towards reducing its accommodative monetary policy, and as testimony to ECB president Mario Draghi’s highly-regarded communication skills, this has been achieved with none of the ‘Taper Tantrum’ effects. The term was originally used to refer to the 2013 surge in US Treasury yields, which resulted from the Federal Reserve’s use of tapering to gradually reduce the amount of money it was feeding into the economy.
The taper tantrum ensued when investors panicked in reaction to news of this tapering and drew their money rapidly out of the bond market, which drastically increased bond yields.
Stock markets continued their rally unperturbed by geopolitical tensions and tighter US monetary policy. European stock markets are finishing the year some 10pc higher while the US betters this with a 15pc gain.
FX markets were essentially flipped on their head from 2016. The euro, one of the chief underperformers for the last few years, was actually the best-performing G7 currency. In a close second place and, with hindsight, quite remarkably was sterling. The dollar fell from grace to be the worst-performing G7 currency for the year. Of note outside the G7, the South Korean won managed a 10pc outperformance against the dollar. With all of the political friction in the Korean Peninsula, such an achievement is counter-intuitive to say the least.
Yet again, inflation continues to be the dog that doesn’t bark. This was particularly the case in the EU and US where despite the best efforts of central bank officials, inflationary pressures remain lacklustre. The UK however has managed to buck the trend with inflation now above the target level set by the Bank of England.
This time last year, President Trump and UK Prime Minister Theresa May ended 2016 as the visions of hope and change among many people in their respective countries. However, both are now finishing 2017 in weakened positions — with both leaders, but May in particular, failing to achieve their set agenda. There is a sense of growing political strife which has already seen them lose some of their core support.
However, the prospect of tax reform legislation in the US and the agreement to move to Phase 2 of Brexit negotiations is perhaps a sign that their fortunes could turn around. LOOKING AHEAD TO 2018 MOST analysts’ view of the 2018 outlook could be summarised as ‘more of the same’. Developed economies are expected to continue their robust growth, and equity markets are expected to maintain their steady bull run. Central bank policy will continue to normalise, driven by gently rising inflation, solid growth and easy financial conditions.
In the US, the Federal Reserve is expected to deliver a further two to three rate hikes.
However, a faster pace of tightening may be warranted if tax-reform legislation finally passes, as well as a planned $1trn infrastructure spend.
Brexit is still top of mind and it’s expected to continue to challenge the UK’s economic prospects, although expectations of a drastic downturn in growth have mostly abated.
Headline risk surrounding the negotiations and exact terms of the UK/EU separation deal will likely maintain the elevated short-term volatility that has been a feature of the pound’s trading pattern since the 2016 vote. The Bank of England is expected to hike rates just once in 2018 but that view is highly dependent on a smooth transition period for the UK economy.
In Europe, the ECB continues to lag other major central banks in tightening policy, but it has signalled a slower pace of QE from January. In addition, given the positive growth momentum, the QE programme is likely to come to a conclusion towards the end of the year. The focus will then likely turn to raising interest rates but this is likely to be more a 2019 story.
In terms of key risks, in Europe, Italian elections are expected by May 2018 with some polls indicating the eurosceptic M5S party in the lead. However, the newly-approved electoral law has made the risk of it forming a government less likely. In the US, mid-term elections are due in November 2018 with risks that the Republicans lose their majorities in Congress which would likely be viewed negatively by equity markets.
And then there’s North Korea, which will no doubt continue to dominate international foreign policy.
When compared to the risks that loomed in January of this year, a geopolitical escalation in 2018 that could upset global markets appears less likely, particularly given the strength of the global economy.
With all major economies set to start 2018 in expansionary territory and modest inflation dynamics likely to keep central bankers cautious, the post-crisis expansion looks set to die of old age rather than a political shock wave.