Strategy & economics
Rising US interest rates offer a glimmer of hope in a world dogged by anaemic growth, weak productivity gains and stagnant wages, write Caspar Rock and Richard Jeffrey
Normal is not what we saw during the decade prior to the Great Recession; normal is a much duller affair
World growth was modestly stronger in 2017. That’s good news – although a world economy growing at 3.5% rather than 3.2% does not reflect a major change in the underlying theme: normal is not what we saw during the decade prior to the Great Recession; normal is a much duller affair.
Alongside the growth in developed and emerging economies, we have also seen poor growth in productivity. Although this has led to much greater job creation than expected in the US, Germany and the UK, for the average working person it has meant low real income growth.
Most major economies saw better growth momentum during 2017. For instance, the increase in US gross domestic product (GDP) looks likely to be around 2.2%, up from 1.5% in 2016. The eurozone also accelerated and, whereas improved growth in the US was in line with forecasts, the eurozone confounded economists’ predictions of a slowdown with growth accelerating from 1.8% in 2016 to 2.2% in 2017. Asian and emerging market economies also saw stronger GDP growth.
On the basis of current numbers, growth in the UK looks to have subsided to 1.5% in 2017, after 1.8% in 2016. However, given past experience, there is reason to believe that activity is being underestimated.
We expect world growth to continue at a similar pace in 2018.
Although the US Federal Reserve (the Fed) began a gentle process of normalising monetary policy two years ago, it was clear that they were looking for reasons to delay the pace of rate increases. This reluctance to tighten has now largely disappeared. As a result, it is likely that faster growth in 2018 will be accompanied by three 0.25% rate rises.
Alongside higher rates, the first steps towards unwinding quantitative easing (QE) have attracted considerable attention. While this is a threat to bond markets and asset prices, we do not think this policy modification is likely to inhibit the bank’s ability to supply credit to the private sector.
The Bank of England has also endorsed a first rate rise. But the adjustment raised more questions. Does the bank believe that the economy will continue to grow faster than its current sustainable rate, and will this cause an increase in core inflation? Will the rate increase turn out to be the first in a sequence and, if it does, at what pace will further increases come through?
An interesting and potentially important development we will be looking for will be the reaction of companies in the US to rising interest rates. We believe that higher risk-free returns from cash and bonds might encourage companies to increase productivity-enhancing capital investment.
For investment markets, this background of continued growth and only a gentle cyclical upturn in inflation leads us to maintain our more neutral view on equities. We continue to be underweight in fixed income within portfolios, particularly government bonds, where we expect yields to be higher in 12 months.
As the year progresses, we may look to lower the overall risk of portfolios (reducing beta in equity, and improving the average credit exposure in fixed income), but this will more likely be a gradual process rather than a big bang.
Richard Jeffrey was Chief Economist at Cazenove Capital until he retired in January 2018.
Chief Investment Officer
Caspar Rock joined Cazenove Capital in September 2016 and is Chief Investment Officer. He joined from Architas Multi-Manager Ltd, a part of the AXA group, where he was Chief Investment Officer and responsible for all aspects of the investment activities, including investment philosophy, process and team. He also oversaw portfolio management at two of AXA group’s private banks. He previously headed up the multi-manager business at AXA Framlington from 2006 to 2008. Prior to that, he managed a range of directly invested equity and bond portfolios, and was Head of European Equities at Framlington as well as a member of the Healthcare team. He has 29 years’ investment experience.
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