This morning, the JCRA team and 100 of our clients gathered at the wonderful Royal Institution of Great Britain to hear presentations from Ian Shepherdson from Pantheon Economics and Bob Janjuah, Strategist at Nomura.
The economic outlook gives no doubt that the global upswing is well underway, but there is caution around being too confident given the very real policy shift over the last year across Europe, the US and the UK. 2018 will see the best global growth figures since 2011. Indeed, the wrinkle lies in the fact that things are a little too good, and labour markets are extremely tight. History would warn us that the prospect of US unemployment potentially reaching 3.5% next year is unlikely to avoid having negative repercussions elsewhere. Wage growth will rise in 2018, and while normally this inflation impact would be offset by some improvement in productivity no one has managed to solve the conundrum of sluggish production yet.
On the FX front, the long-held US strong-dollar policy has been put into jeopardy by the more erratic policy stance from Mnuchin – almost welcoming a weaker USD. This is being played out in the FX markets and looks set to continue in the near term. EUR/USD movements since the beginning of the year have definitely caught some people out, with Ian’s conclusion being that the FX market simply does not believe the ECB while the rate market does. For the UK, inflation questions were on the forefront of the audience’s mind, but all other things being equal (ie no change in government, and no big Brexit shocks), headline and core inflation look set to be just below the 2% target through the end of 2018.
Bob encouraged the audience to think about how much wage growth we should tolerate, making the point that only by allowing this wage growth to filter through will there be any chance of rebalancing inequality. This is about diverting return on capital (asset price inflation) toward returns on labour (wage inflation). While this inequality might look purely like an economic problem, it is the reason for the political outcomes we have witnessed in the last year or so and, unless addressed, will mean further political ‘risks’ on the horizon. This has been a hot topic at recent Davos talks and it will be interesting to see whether it results in a shift away from the traditional policy model of stamping out such inflationary pressures as wage growth. This, combined with the highly indebted position most economies find themselves in, gives a tone of caution to the traditional rate-hiking cycle one would normally expect.
Looking specifically at Europe, Bob recommended keeping an eye on the Italian elections later this year, warning that a shift in European monetary policy was unlikely before that. However, the ECB is significantly behind the curve, so we could well see an agreement on the direction of interest rates (up) with perhaps even more than the market is expecting, combined with a speeding up of the tapering.
On the markets, the long equity position could still be a good trade for 2018, but there will be an opportunity at some point this year to trade out and buy bonds – as yields rise and this asset class looks relatively more attractive. Turning to risk management, the price of hedging currently is low (on very low volatility) – this cannot continue, and higher volatility in the equity and FX markets will make hedging more expensive as the year progresses.
From JCRA’s perspective, we launched our 2017 yearbook and highlighted our 2018 themes for the derivative and debt markets: Ring-fencing, EMIR (Margining), IFRS9, LIBOR replacement, FX volatility, and (of course) rising interest rates.