The global economy continues its synchronised recovery, as evidenced by robust data across regions. Indeed, all 45 countries tracked by the Organisation for Economic Co-operation are expected to post positive economic growth in 2017 for the first time in 10 years. Even more optimistically, 33 out of 45 countries are seeing accelerating growth. This has boosted international trade and commodity prices, and helped make the global expansion story gradually more self-sustaining. On this basis alone, the prospects for 2018 look positive, with broadbased improvements across the major developed economies and a number of emerging market economies expected to continue.
The synchronised economic expansion that we’ve seen post the global financial crisis has helped stock markets rally and boosted the profits of many multi-nationals – creating what some might call a sweet spot for equities. The longer that global macro data continue to trend higher the longer that the globally synchronised earnings upturn will remain compelling. Moreover, the benign global inflation environment has allowed central banks to keep monetary policy very loose – for now.
However, we will not remain at that sweet spot forever, and there is reason for caution. Are we in for a period of stronger, more decisive change in monetary policy? It’s certainly possible. The US Federal Reserve (Fed) has said that it would stick with plans for further interest rate rises, and it has thrown its crisis-era stimulus programmed into reverse. Meanwhile, the Bank of England (BOE) raised UK interest rates in November, and the European Central Bank (ECB) announced that it was looking at how to reduce the amount of economic stimulus it is currently providing. Everyone has been so used to the accommodative stance of the past 10 years, and markets have become complacent.
But what if interest rates rise and central banks exit quantitative easing faster than expected? How would global financial markets react? This isn’t a scenario that’s priced in at the moment.
The beginning of a new era
The global financial crisis of 10 years ago was a watershed event for financial systems around the world. Systematic losses by banks and the ensuing losses in economic output spurred governments into action. Governments in advanced economies stepped in to provide support to banks and other financial institutions, as traditional sources of funding dried up. Central banks reacted to the downturn by cutting interest rates and expanding balance sheets simultaneously by buying securities funded via the creation of excess reserves.
We are now entering the phase of the “great unwind,” with the Fed beginning to slowly sell the $4.5 trillion in assets it bought to stabilize the economy. It’s a real milestone to reach. Could this be the beginning of a new era? The Fed has made lots of reassuring noises about the care it will take, but this is an unprecedented action. No one can be sure that policy mistakes won’t be made, disrupting bond and equity markets around the world. Even if the Fed’s reduction of its balance sheet is uneventful, the BOE, ECB and Bank of Japan all have to go through the same process at some stage.
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