Questions Remain as Political Uncertainty Wanes – For NowLearn more about this firm
Overall, it is probably fair to say that economic development and capital market performance in the first half of 2017 were respectable. The worries caused by the political unpredictability of this “super election year in Europe” now appear to have more or less receded. While some are enjoying the respite offered by summer, investors looking ahead to the second half of the year are focusing on key questions about growth, inflation and central banks.
1. Will growth forces continue to prevail?
A belief that global economic growth will pick up in the short term continues to guide market performance. And in fact, the global economy is experiencing an upswing. Business sentiment is buoyant, especially in industrial countries; even in emerging markets, the economic outlook has improved. However, a sweeping increase in the pace of economic growth is unrealistic. Indeed, there are signs that unexpected positive news is tapering. At the same time, there will likely be a renewed, more intense focus on the disparities between countries. Regionally, the euro zone should continue to stand out with healthy growth momentum, for now.
2. Rising inflation: Was that it?
Headline inflation rates are fluctuating between temporary effects and slow trends. While the increase in inflation due to oil prices – which are higher than in the prior-year period – is gradually weakening, the decrease in unemployment in major industrialized countries has not yet resulted in noticeable upward pressure on wages. For the time being, central banks are fairly patient. After all, the reflation scenario – i.e., in which economies continue to recover and inflation picks up moderately – remains essentially intact.
3. Will central banks be able to execute a deft change of direction?
While subdued inflation figures appear to be a source of some concern for the central banks from Washington to Frankfurt and Tokyo, their basic strategy remains clear: a gradual return to normal monetary policy. This should not be confused with a tighter monetary policy, though. Interest rates may be gradually rising in the US, but they are still low compared to inflation. Moreover, although there are signs that the Federal Reserve plans to reduce its inflated balance sheet, this will take years. In the euro zone, on the other hand, the European Central Bank is only taking the tiniest of steps toward a “QE Exit”. If and to what extent market volatility increases as a result of a change in direction will mainly depend on how carefully central banks manage expectations with regard to their exit strategies, not least as demonstrated by the most recent appreciation of the euro.
What does all this herald for the financial markets? For the time being, drivers of growth around the world should continue to prevail, giving further impetus to the equity markets. However, three main issues – euphoric business sentiment with little room for improvement, at least for now; central banks’ challenge of how to handle communications while finessing the balancing act between normalization and tightening; and the political risks that have receded into the background for now – beg the question of whether the all-time lows in the volatility indices are justified. These are conditions that call for the skill and intuition of active fund managers who can seize the opportunities arising from fluctuations and disparities among countries.
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