Get ready for a volatile ride

THE economic backdrop remains highly supportive. The world economy is in the midst of a broadly-based and globally synchronised expansion, with limited evidence of economic or financial imbalances that could pose a threat to the recovery.

However, with the yield sharply rising, it could prove to be a potential burden to the US’ recovery as credit spread between corporate loans and US treasury widen further .

We expect a little over four per cent global growth through 2019, with a limited (and largely welcome) revival of inflationary pressures, permitting a very gradual normalisation of monetary policy in the major economies.

The equity market downdraft in February highlighted investors’ sensitivity to risks of higher inflation and tighter money.

We consider such concerns premature.

In our view, the downdraft signals a more general end to the unusually stable market conditions seen in 2017.

We expect a more normal level of financial volatility as investors react to news in line with historical norms.

In next the next three to six months, downside risks stem mainly from the potential for an economically disruptive trade war. We believe that the risk of an all-out trade war that upsets the global expansion is still low for now.

However, we do not expect a rapid de-escalation.

The markets are likely to remain exposed to headlines that raise wariness about the tail probability of a highly disruptive breakdown of trade relationships and global supply chains.

Investors also face the risk of a policy backlash against the business practices of some large technology firms.

After the 2018 backup in US yields, and smaller backups in gilts and bunds, dollar bonds provide a less punitively expensive haven from policy risks.

We scale back our longstanding equity overweight position over fixed income to a mild underweight, with most going into US fixed income.

Similarly, we are stepping away from our longstanding call to most emerging market (EM) assets, to a more selective outlook, generally favouring sovereigns over EM corporates.

However, we would still look to buy risk assets on weakness.

Although the economic backdrop is similar to 2017, we think a more tactical approach will be needed in 2018, given heightened risks, especially from trade policy.

Investor should brace for greater market volatility and should seek to be more cautious ahead as the possible trade war between powerful nations from both the West and East economic power houses could derail the global economic balance .

February’s market correction now qualifies, we suppose, based on economic history.

But it leaves us with some lessons learned and a large enough shift in the market context to deserve some consideration.

We were surprised that markets were as susceptible to an outbreak of anxiety about inflation and monetary policies as they proved to be in February.

We understand why investors assign so much significance to the ultra-supportive monetary environment.

But we were taken aback that many responded so strongly to what was, in fact, only a weak sign of a rising inflation.

For example, the US core CPI print of 1.8 per cent in February that made investors nervous should be considered as light due to the fact that US core CPI averaged well above two per cent in 2016.

Similarly, the average hourly earnings series only got to 2.9 per cent nominal (real wage growth below one per cent) in February, and the trend reversed in the March report.