February 17, 2017 by Karl Schamotta
Donald Trump’s personal approval ratings may be plumbing historic lows, but global economic spirits are improving at a spectacular pace. With investors overwhelmingly convinced that this year will bring higher growth, inflation, and interest rates, markets around the world are set to close out the week on a broadly positive note. Equity bourses are trading in nosebleed territory, with the FTSE 100, S&P 500, and Stoxx Europe 600 all trading near record highs, while commodity prices continue to strengthen in the background.
The dollar is slightly weaker, falling even after Janet Yellen appeared almost unnervingly confident in Congressional testimony earlier this week, that the economy’s growth trajectory would continue through the year, with inflation heading north of the Federal Reserve’s 2 percent target. In her semi-annual address, the infamously dovish central banker suggested that her institution’s December forecasts remained intact – meaning that three interest rate hikes remain possible over the coming ten months. Real gross domestic product growth and consumer spending are nearing record levels, with the Trump administration’s plans to lower taxes, reduce regulation and increase fiscal spending adding fuel to an economy that has regained its place among the most world’s dynamic over the past few years.
This seemingly counter-intuitive trend echoes historical patterns – when the globe’s biggest consumer begins to grow, the currencies of countries that ship raw materials, manufactured goods and services to the United States tend to rise.
Even the euro and sterling are both holding up remarkably well, trading within 1-percent ranges despite increasing political turbulence on both sides of the Channel. French bonds are undergoing a slow-motion selloff, trading in volumes last seen during the bad old days of the euro crisis, as an increasingly polarized political landscape raises the possibility that an anti-market government assumes power in a few months. Socialist Party presidential candidate Benoit Hamon announced yesterday that he was discussing the prospect of uniting his candidacy with Jean-Luc Melenchon ahead of the election, meaning that the far-left could represent the only viable alternative to Marine Le Pen’s far-right party in a run-off vote. This is doing little to damage the euro however – with virtually every country in the economic area in growth mode, the need for additional monetary dilution is rapidly ebbing, helping the common currency to claw its way higher on the crosses.
In the United Kingdom, former Prime Minister Tony Blair threw a wrench (or a spanner if you will) into the works last night, making a speech in which he called for the formation of a centrist political movement to oppose leaving the European Union. He said, “The people voted without knowledge of the true terms of Brexit. As these terms become clear, it is their right to change their mind. Our mission is to persuade them to do so”. This came after a retail sales report showed that consumers had cut spending for the third month in a row, indicating that a surprisingly strong rebound after the membership referendum may have run out of rope – and suggesting that Mr. Blair’s message may attract more listeners in the months ahead.
On a global basis, currency volatilities are falling, with the drumbeat of negative news out of Washington doing little to convince traders that the worldwide growth story will go off the rails anytime soon.
This appears broadly justified. On closer inspection, a much-ballyhooed global populist uprising appears to be motivated by a rejection of sixties-era left-right political pluralities more than a true revolution against liberal capitalist democracy, and thus doesn’t necessarily represent a true turning of the tide. Protectionism also seems a less potent force than media reports might have us believe – while international trade growth has fallen, it seems that a fall in commodity prices is more likely to be the true cause. There has been no discernable rise in tariffs or trade barriers, and volumes have rebounded materially, with container shipments hitting record levels in the latter months of last year. Most importantly, while inequality is rising within many developed countries, billions of people in poorer countries are seeing their living standards improve. In short, the global economy is growing faster, and from a much larger base than ever before.
Of course, in what has seemingly become an annual tradition, we feel compelled to warn our readers that prolonged periods of high growth and low volatility tend to sow the seeds of their own demise. An improving global backdrop can encourage market participants to plow enormous sums into largely homogenous trades, while loading up on leverage – essentially filling a powder keg that inevitably explodes when something unpredictable occurs.
Thus, while this recovery should be celebrated, we would urge corporate hedgers to capitalize on what may be a short-lived opportunity to put protection in place. The forward and options markets are working near peak efficiency, meaning that taking out insurance against downside is currently relatively cost-efficient. This won’t last.
As Warren Buffett likes to put it, “Be fearful when others are greedy – and greedy when others are fearful”.
Have a great long weekend!
Director, Global Product & Market Strategy
Study materials for your Reading Week:
Financial Times: Do Not Blame the Euro Simply Because It’s There
Reuters: The Lesser-Spotted Redback
Liberty Street Economics: Houses as ATMs No Longer
Maclean’s: Population Growth Isn’t Driving Toronto House Prices
NBER: Exchange Arrangements Entering the 21st Century
Bank for International Settlements: Are We All Macroprudentialists Now?
Federal Reserve: Slow…Labor…Productivity…Growth
Government of Dubai: Mars 2117
Macro Musings: The Monetary Superpower Is Strong As Ever
Bank Underground: The Good, the Bad and the Bubbly
Nobel: The Pretence of Knowledge
CityLab: Ghosts and Ghost Cities
New Yorker: Subtle Hints
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About the Author:
Karl leads Cambridge’s currency research group, focused on analyzing shifts in the world economy and creating strategies that help businesses harness market volatility. He has built risk management and trading programmes for hundreds of major corporations and has extensive experience in managing exposures across major, minor and exotic currencies. Karl is a regular contributor to a number of international finance publications and is often quoted by the Wall Street Journal, Bloomberg, Reuters, CNN, and CNBC.