Assessing 2018 Consensus and Risks to Views

I’ve spent a lot of time over the last week  participating in “2018” Outlook events, reading and writing outlooks. At the risk of adding to the deluge, its worth a few reflections about the status of consensus and where triggers might diverge.
Almost everyone I’ve spoken to over the last few months  is upbeat and sees a continuation of the “synchronized global expansion,”* benign liquidity conditions and pricey valuations getting even more pricey. Some countries and sectors look less resilient, but the general view is quite positive, almost too much so given the agreement.

Some are a little worried about 2019 or H2 2018 or Q4 2018 when the effects of balance sheet adjustment might begin to be more priced and when questions escalated on what might be the new drivers of growth. In this context, regulatory uncertainty especially around trade and investment policy might reinforce recent investment trends, as some corporations and households hold off on spending.

2018 is likely to be a year of relatively robust global growth similar to the post-crisis peak.  A needed slowdown in Chinese growth will likely offset by recovery in several other emerging markets (especially India and struggling oil producers), the U.S. and Europe continue to grow above potential and global central banks (especially Japan, Europe and China ) continue to provide significant liquidity despite a move away from aggressive liquidity provision in 2018.
Even Latin America and the Middle East and Africa, the global laggards are likely to stage a modest recovery, helped by stronger commodity prices and easier liquidity. The gradual pickup in wage pressures and unit labor costs is a sign of this expansion, particularly in countries in developed Asia and Europe, allowing for policy adjustment.  2018 will likely be a year when post-2011 expectations of potential growth are tested. The new normal is now consensus.
What are the flies in the ointment?

  • US fiscal policy The details of the fiscal plan remain unclear and as with anything written at 2am likely have unintended consequences. The details suggest little growth kick and the incentives point to a transfer to those with more propensity to save (richer investors) and less propensity to consume. A sharper readjustment could accentuate these trends and add to the impact of tighter monetary policy. Moreover, companies and households might hold off on spending until the implications are clear. In particular the impact on residential real estate seems clear.
  • Inconsistency between fiscal, trade and foreign policy goals. A wider fiscal deficit and greater government debt issuance suggest USD strength and weaken overall net savings. Despite the limited benefit to growth and limited new flows into USD as most of the corporate savings are already in US assets at home or abroad, the direction of travel suggests a wider external balance, which flies in the face of other policy goals. Meanwhile the trade off between Asian security and economic issues may become more challenging (see policy on South Korea and China).
  • Chinese policy mix focused on stability at home and seeking global demand. Investors and policymaker are very comfortable with the outlook, the ability of the country to use its policy tools in times of moneymarket stress, but the quality of growth still leaves much to be desired. With the earnings outlook weakening, 2018 could be bumpier in terms of output and impact on its trading partners.
  • Pressure to act on rhetoric and respond to policy reviews (U.S.) adds uncertainty for corporate planning. Several trade and investment reviews are due including a wide succession of targeted measures on China. Meanwhile election pressures increase the incentive to show returns,. The NAFTA talks will be a key case as will the one-off policy measures. Meanwhile we will get a better sense of which if any of the “Plan B” trade agreements materialize and whether they encourage a shift in domestic policies (domestic regulation and fiscal policy are more important in driving competitiveness than agreements per se. Uncertainty on trade, banking and other rules complicates planning and could encourage front-loading of activity or delays. This risks increasing the cost of businesses  in dealing with regulatory divergence. 
  • Refinancing issues: With global liquidity easing EM countries have a sizable amount of debt to rollover. Average 5 year rates have come down sharply in aggregate but with global central bank buying less supportive, some vulnerable credits may be subject to repricing.  I’ll discuss which in an upcoming piece.
  • Market/policy reaction in monetary policy and oil: The coordination between the “exit” of global central banks and the (N)OPEC agreement. Q4 2018 is likely to be the period when the net balance sheet growth of global central banks will begin and when oil producers may be looking to exit their liquidity adjustment. Will the coincidence add to volatility across a range of assets.
  • Political pressures restraining investment, limiting revival and resilience in some EM: Political cycle in Latin America and some other EM leading to status quo policy and little change which reinforces consumption driven growth, caps potential and leads to revival of inflation despite sluggish growth. Key to watch are Brazil (inaction on fiscal/pension), South Africa, Turkey, Indonesia, Saudi Arabia. 

What could go better than I expect?

  • More infrastructure spending. There are several aggressive spending plans, across most jurisdictions -including Latin America (Argentina). So far there have been financing issues and actual realized investment has been lower than hoped. Institutional investors I speak to Greater such investment would prompt
  • Tighter labor markets lead to income growth and some redistribution, contributing to a different distribution of growth.
  • Fiscal stimulus in some surplus countries to address imbalances (Korea, China, Germany, Netherlands). Challenge is that authorities see some signs of overheating and don’t recognize the imbalance issues.
  • Positive feedback loop from global growth,  drawing down inventories and leading to more aggregate demand. Evidence of this would come from an increase in final demand especially in Asia and Europe.

What have I missed?
* 9 years is a long time to be waiting on recovery. I prefer to employ the term recovery for a number of struggling countries, mostly commodity producers recovering form the struggle.

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