Growth and Confidence, but not Complacency
By Christophe Morel, Chief Economist at Groupama Asset Management.
Our economic scenario draws the distinction between structural analysis (long-term) and current situation snapshot (short-term). Without doubt, we are more prudent than many others concerning the long-term environment but more optimistic than average regarding short-term prospects. “While the current economic situation is going well,” investors are likely to prefer “the glass that is half-full to the glass that is half-empty”.
Obviously, financial assets would be vulnerable to a slowdown in the overall economy.
Our structural analysis describes an environment of durably low growth and high levels of public and private debt both in the developed and the emerging countries, prompting the need for “financial repression” (i.e. control of the yield curve by central banks) to counter a long-term risk that is more deflationary than inflationary. This vision evidently compels us to beware of complacency.
However, our analysis of the current economic situation remains very favourable for the next two years, with quite high confidence in the growth prospects of the developed countries and statistics for cyclical inflation (underlying inflation) that we predict will be surprisingly high. Essentially, growth is supported by three factors:
- the main reason is purely cyclical, in that there is always a delay in reconstituting stocks and in investment;
- secondly, external imbalances are globally contained, although there is a real concern crystallizing concerns the US current account deficit and the Chinese surplus;
- finally, monetary policies remain very accommodating and are, overall, well-coordinated with fiscal policies (for example, the Chinese current account surplus in theory requires an expansive fiscal policy and more restrictive monetary conditions, which is what we observe is happening in practice.
The emerging countries will benefit from the recovery in the developed countries but will not be the driving force of this recovery, precisely because they are further ahead in the production/investment/debt cycle.
Given this principal scenario, the balance of risks is generally positive in the short term and negative in the medium term. In the short term, the confirmation of tax reform in the United States and the trend of world trade could induce us to revise our growth forecasts upwards.
In the medium term, there are two main downside risks: first, the risk of massive fluctuations in foreign exchange or financial assets, which could lead to a tightening of financial conditions, and; second, the trend of widening inequalities and the increasing financial insecurity of employees are durably exacerbating the political and social risks.
In terms of our money market scenario, this implies that:
- For the Fed, the unconventional monetary policy has clearly started to tighten, since the balance should fall from 22% of GDP at present to 14% of GDP by the end of 2019. Conventional monetary policy should also tighten, with an increase in Fed Funds in 2017 and 3 hikes in interest rates in 2018 to attain the “neutral” nominal rate, which is considered to be 2%-2.5%. So, in a year’s time, we will be speaking of the end of the tightening cycle in the United States.
- For the ECB, it is time to envisage the end of the cycle of marginal monthly purchases, already scheduled for next September, due to the upward revisions of nominal growth, the operational constraints imposed by the rarity of the securities (especially in the case of German bonds) and a Governing Council that is increasingly divided on the asset purchase policy.
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