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Global economic outlook for financial markets

On 14 October the ECCT hosted a Premium Event lunch on the topic "2017 global economic outlook for financial markets - Implications of the UK's vote to leave the European Union" featuring guest speaker Guy Stear, Head of Corporate Credit Research and Emerging Market Strategy at Societe Generale (SG) Corporate & Investment Banking. The speaker provided a synopsis of major global macro-economic trends and an outlook for the global economy in 2017.

 

While global economic growth in 2016 has not met expectations, the rise in commodity prices has helped emerging markets while low interest rates have been maintained. Stear expects 2017 to be much more volatile, especially in United States. He remains bullish on emerging markets given the recent rise in commodity prices.

To paraphrase Donald Rumsfeld, the "known unknowns" (where the events are anticipated by the outcome is uncertain) that will affect the global economy in 2017 are Brexit, US politics and China.

2016 has followed the same pattern as every year since the global financial crisis: analysts have had to periodically trim their initial optimistic expectations for GDP growth in line with real outcomes that were lower than expectations. The biggest disappointment has been in the United States, where economic growth has been about one percentage point lower than expectations. Growth in Europe has also been disappointing. However, the rise of commodity prices has been a boon to commodity-producing countries, such as Russia and Brazil, helping to boost their currencies and equity markets.

Bond yields had risen following the US Federal Reserve's (the Fed) first quarter-percent rate rise in 2015 and expectations of further rate hikes in 2016. However, yields declined when there were no further rate hikes in 2016. Yield's troughed and then began to rise after the summer in expectations of potential rate hikes in 2H16 but they are still lower than they were at the beginning of 2016.

SG's GDP forecasts for the next four years show that Europe will continue to disappoint with a peak growth rate of 1.5% in 2016 and gradual deceleration to a trough of 0.7% in 2019. Forecasts for the US show a peak in 2017 and gradual deceleration thereafter. SG economists expect a technical recession (two quarters of GDP declines) in the US in 2019 (although they expect full-year US GDP growth of 0.2% in 2019) before a sharp uptick starting in 2H19.

Stear believes that China's performance has been better than expected in 2016. A slow deceleration is inevitable given the current size of the economy. He expressed the view that China's economy is too large now to rely on exports to boost the economy but that the rebalancing of the economy towards internally-driven growth is a positive trend. In this regard, higher wages are good for domestic growth.

On currencies, SG expects one more Fed rate hike in 2016 and two more in 2017 to bring the Fed rate to 1% by the beginning of 2018. This is based on the view that the Fed wants to raise rates while the US economy is still in good shape in order to give them more leeway to cut rates when the next downturn occurs. He also believes that the Fed is reluctant to embark on further quantitative easing. Based on these views, SG expects a stronger US dollar versus other major currencies (the euro and the Japanese yen) and minor depreciations of the Chinese Yuan and the Taiwan dollar over the next two years.

Stear expressed concern about excessive leverage in the US. He said that balance sheet leverage in the US is higher now than it was in 2008 and as high as 2002, the peaks of the two most recent default cycles. However, unlike 2008, which was all about the banking sector, the rise in defaults since 2014 has been especially strong in the energy sector and, to a lesser extent, the mining sector. Stear believes that defaults could get worse if the US economy slows and there are more defaults elsewhere.

The forthcoming "known unknowns" are the Italian constitutional referendum in December 2016, British Prime Minister Theresa May's decision to trigger Article 50 notification in March 2017 (which would start the two-year countdown for the UK to officially leave the EU) and elections in The Netherlands, France (two rounds in April and May 2017) and Germany (in October 2017). Stear expressed the view that May has to demonstrate a tough position on the UK's exit from the EU in order to satisfy the conservative elements in her party and the broader electorate. She has agreed to a parliamentary debate (although not a vote) and ruled out another referendum. In Stear's view the triggering of Article 50 will not lead to immediate negotiations because European leaders (especially in Germany, France and Italy) will be too preoccupied with their own domestic affairs. In addition, negotiations are going to be extremely complicated, making reaching a satisfactory deal very difficult in just two years. May has proposed a wholesale adoption of all EU laws initially, after which, unwanted aspects can be repealed item by item.

Negotiation battle lines are already being drawn. EU Council President Donald Tusk and several national leaders have said that there would be no compromise on their insistence that freedom of movement will be a condition for the UK's access to the single market while UK Brexit supporters insist on having control of immigration. It is difficult to see how a compromise on these opposing positions can be worked out.

While there was a short initial shock following the Brexit vote, UK markets recovered on the back of good economic data during and after the summer. Things took a turn for the worse recently when Prime Minister May announced the March 2017 deadline for triggering Article 50. The outlook from here on out looks very uncertain and will depend very much on how Brexit negotiations proceed.

On the subject of US politics, while Stear does not believe Republican presidential candidate Donald Trump will win the US presidential election, he speculated hypothetically that a Trump win would bring an initial boost to the US economy given Trump's promise of tax cuts and spending on infrastructure. However, the medium outlook for growth would be negatively affected if Trump imposed (as he has alluded to) restrictions on trade and immigration. By extension, a Trump victory would also be negative for trading partners such as Mexico, South Korea and Taiwan.

On China, Stear expressed caution about rising property prices, especially in certain cities, where rises have been too steep and too fast to be sustainable. Rising debt and the risk of defaults in China is also a concern.

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