Over the past month, global growth indicators stayed upbeat and inflation expectations extended a recovery toward targeted levels. We repositioned ourselves for a euro setback against Sweden’s krona and note that equities in Europe and Japan are regaining steam. The latter may also be about to finally break out of its deflationary trap for good.
In this report we update our macro assessment for the next three to six months as set during our quarterly tactical asset allocation (TAA) review in mid-September.
Geopolitical tensions eased somewhat in Asia over the past month, although some long-simmering European political divisions resurfaced again (e.g. Catalonia, Brexit). But these issues impacted only certain market segments (e.g. Spanish stocks, British pound). Most major markets and the global macro data remained upbeat regardless, while interest rates and inflation expectations continued to recover moderately.
The global economy is maintaining momentum: for the first time since 2010, the seven largest developed economies had two consecutive quarters of synchronous growth, while the top-eight emerging markets (EM) completed their first such quarter since 2014.
Business surveys also picked up again, most notably in Europe, where the Eurozone’s purchasing manager survey once again surged from already high levels. The corporate earnings outlook remained robust as well globally, while inflation data ticked up - although actual annual inflation readings remained below the targeted 2% in most cases.
Against this background, the Federal Reserve in late September as expected decided to start shrinking its balance sheet (i.e. “quantitative tightening”). Simultaneously, however, the Fed also lowered its median forecast for the long-term policy rate from 3% to 2.75% and hence slightly flattened its projected tightening path (known as the “dots plot”). In addition, the minutes of that particular Fed meeting last week revealed another dovish tilt by noting that “many” participants had expressed concern about persistently below-target inflation. These developments confirm that the Fed remains cautious about its own tightening plans, which is good for growth.
In this context, it is worth recalling what happened since mid-June, when the Fed decided to postpone further rate hikes until December: market-based inflation expectations (i.e. the so-called breakeven rates) immediately started to recover toward the targeted inflation level - after steadily declining during the preceding half year. In the meantime, long-term US breakeven rates have broadly hit the target of 2%. The Fed is thus likely to hike rates again in December, as is largely priced in at present.
Nevertheless, the lack of upward momentum in US breakeven rates, combined with the even lower breakeven levels in Europe (not to mention Japan), continues to highlight that central banks do not have much room to err on the hawkish side. If they start sounding too eager to tighten policy, expectations could easily sink back again. As long as central banks take their own official targets seriously, hawkish policy surprises thus continue to be less likely than dovish ones.
Note: The next edition of the LGT Beacon is scheduled for 8 November 2017.