Anthony Willis: What’s in the crystal ball?

By Anthony Willis

Feb 21, 2019
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Economic predictions for the coming year

The crystal ball for the next few months appears particularly foggy. There are questions over how long the current economic cycle can last, along with no shortage of questions over politics and the path of interest rates. 

Currently, there are reasons to paint a pretty bleak picture – economic growth is slowing, while there is increasing uncertainty over how far central banks will go in tightening policy.

This comes amid heightened political risks and trade wars, as well as concerns over nationalism and populism as politics shifts towards extremes. The International Monetary Fund estimates that global growth in 2019 will be around 3.5 per cent – down from 3.7 per cent in 2018 – with emerging markets picking up the baton from a slowdown in developed markets.

Much of the damage has been self-inflicted, with trade wars affecting growth in China/Asia, and, closer to home, the uncertainty of the Brexit process weighing on the UK economy.

US president Donald Trump, mindful of the 2020 election, will not want to oversee a significant economic slowdown, so there remains potential for further measures to boost growth in the country.

Assuming interest rates continue to normalise, the cost of servicing this debt will increase and act as a brake on growth.

Given the forward-looking nature of markets, pricing in a slowdown in economic and earnings growth is likely to happen long before the slowdown actually occurs. Central banks are very aware of the distortions caused in financial markets – as well as corporate and consumer behaviour –by almost a decade of near-free money.

The key central bank to watch is the Federal Reserve. It is already some way through its hiking cycle, although with inflation at target and the US economy at full employment, it could feel compelled to continue raising rates, not least if the government continues to binge on debt to fuel economic policies, and economic data remains robust.

Recent signals from the Federal Reserve that it is close to ending its hiking cycle have been welcomed in markets, although history tells us the end of such a cycle normally coincides with an economic slowdown, often caused by the rate hikes themselves.

The Bank of England, faced with low unemployment and rising wages, is also keen to tighten policy, but will have to wait until there is more certainty on the Brexit outcome.

As for the European Central Bank, we have seen quantitative easing come to an end, but a tightening in policy seems some way off.

We may see a technical rate hike at some point, however, as the ECB looks to support banks impacted by years of negative interest rates. The Bank of Japan is still some way from its inflation targets, so we do not expect any significant policy shifts there for now.

Emerging market central banks are in reasonable shape to cut rates should growth ease, and do not have many of the issues of their developed market peers, in terms of bloated balance sheets from quantitative easing.

The tailwinds of ultra-loose monetary policy are behind us, with central banks seeking to normalise policy, albeit at a gradual pace.

There is considerable uncertainty in the world of politics and, in some cases, politics is acting as an impediment to global growth.

We also see earnings growth set to slow, at a time when valuations cannot be described as cheap and firms are sitting on significant amounts of debt.

Indeed, the costs of servicing debt – for governments, households and corporates – have been exceptionally low for a long time.

Over the coming years, rising interest payments will likely have a significant impact on economic prospects. The baton could be picked up by politicians, with fiscal stimulus and an easing back of the rhetoric on trade wars, but, given the levels of debt built up, the ability of governments to introduce large-scale stimulus may be limited.

With the headwinds of slowing growth and central banks easing back on their stimulative measures of the past nine years, investors are likely to have to work harder for their returns.

Anthony Willis is investment manager in the multi-manager team at BMO Global Asset Management

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