Central bankers’ hawkishness is no cause for alarm in 2018

Between The Lines Craig Jamieson

Central bankers in the US and Europe will rightly remain keen to wean their patients off emergency monetary support. This, alongside an increasingly vibrant world economy, should make life tougher for the bond market in 2018.

Rising interest rates across the curve should, in turn, provide a stiffer headwind to equity markets than seen for much of 2017.

This should be the case anyway, in truth. The investor community is less obviously gloomy about the economic and political prospects for the world – the health of the global economy has become less debatable as past turbulence in the dollar and oil prices has gradually relaxed its grip on various economic statistics, including corporate earnings.

Stock markets are simply pricing the outlook for the world economy more sensibly than they were at the beginning of 2016.

However, even though expectations look closer to reality and bond markets less friendly, we still see stocks continuing to reward investor pluck.

The decent earnings growth forecasted by surveys, consistent with the increasingly rosy health of the US and global business cycle, is central. Investment is also picking up, suggesting that global demand has become less reliant on the broad shoulders of the developed world consumer.

Meanwhile, the emergence of a plausible upside scenario in Europe, distinguished by a more collegiate political backdrop, a healthier banking sector, and even meaningful steps forward in the construction of a credible fiscal and political architecture for the euro, should help continue to drag the whole distribution of outcomes for European risk assets higher.

Of course, not all risks have disappeared, just those that mistakenly preoccupied many at the beginning of this year.

The primary risk for us now centres on the bond market and monetary policy. Central bankers have a wobbly tight rope to tread, perhaps buffeted by a bond market that has become too used to falling yields. Remember that you have to go back to the election of Charles V as Holy Roman Emperor to find an interest rate rally of comparable scale to that seen since Paul Volcker’s “war on inflation”.

It may be wrong to assume that this historic bull run in interest rates ends in benign fashion, as we currently do. There are certainly scenarios where central bankers, still locked in post financial crisis fire-fighting mode, react too slowly to the signs that heat is rising in the world’s important economies.

To that end, the more resilient hawkishness on display from the world’s central bankers in the final stages of this year should be a source of reassurance as we look into 2018 rather than alarm. l Craig Jamieson, regional director, Barclays, wealth & investments, west of Scotland & Northern Ireland.