This year we mark the 10th anniversary since the global financial crisis. It has been a long, arduous journey but if we look at the world economies, we find that, on balance, they are in pretty good shape. Global growth of 3.8 per cent in the past six months is the best we’ve had for the last five years and there appears no sign of a slowdown, as yet.
It has not been easy getting here. We have all been part of an unprecedented experiment, in the form of quantitative easing (QE), the result of which was by no means certain. And large risks remain. We are now in the middle of a crossroad that is marking the end of this experiment.
The US has turned its QE into quantitative tightening as it now seeks to shrink its balance sheet by buying fewer US treasuries than the principal repayments it receives on maturing securities, thereby effectively taking cash out of the economy. At the same time, the Federal Reserve is also raising interest rates, thereby increasing the cost of money. A further two increases are expected in 2018.
At the same time, the European Central Bank (ECB) is also signalling the end of its QE programme. This is expected by the end of 2018, with late 2019 expected to see the first interest rate rises in Europe. Savers may at last start to see some long-wished-for relief from the pain of zero bank deposit rates, though the outlook in Europe is even more cloudy than our beloved dust-filled island.
For risk assets, this has significant implications. At its most simple, the 35-year bull market in bonds has come to an end, most obviously in the US but also in Europe.
But the implications are much wider. For almost 10 years we have had easy money. Due to zero interest rates, money has sought returns in assets away from traditional bank deposits. While in Malta this has partially manifested itself in the robust property market; internationally we witnessed bull markets in almost all asset classes.
Although economies are indeed growing nicely, it does not take much to reverse the momentum
As the cost of money starts to rise it becomes less obvious which asset class continues to offer good value. Investors are and will become even more selective on where to place their savings.
This uncertainty has already manifested itself in a greater degree of volatility in equity markets. While this does not necessarily mean equity markets won’t perform well, it means there will be greater divergences between the good and bad performers. The good economic momentum though should prevail in 2018, by providing headroom for companies to increase profitability.
Against this backdrop, a new phenomenon, for the younger ones among us, is developing in the form of a trade war. For the last 30 years or so, international trade has grown almost unabated – remember GATT, the General Agreement on Tariffs and Trade. Barriers in the form of tariffs, even currencies, have reduced, allowing for a greater degree of cross-border trade.
This trend is now reversing. The new politics is more populist and more protectionist. Economists are now busy dusting off their text books to revisit the likely implications of the introduction of trade tariffs. A base case approach suggests that the new tariffs will be inflationary for the US economy, and depending on where the impact is absorbed will also lead to a slight contraction in economic activity.
On this side of the pond, the inward approach to politics is also leading to a more protectionist approach, manifesting itself most obviously in the current migrant crisis. The Brexit mess is also another case of an inward-looking approach taking front stage. For consumers, uncertainty only does one thing. It forces lower spending.
Ironically this uncertainty may force central banks to reassess the degree to which they tighten the economic belts. Although economies are indeed growing nicely, it does not take much to reverse the momentum. Indeed, the US yield curve is already indicating the possibility of an oncoming recession as it approaches the point of inversion. One hopes that bad politics does not also lead to bad economics. Watch this space!
David Curmi is managing director of Curmi and Partners Ltd.
The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd is a member of the Malta Stock Exchange, and is licensed by the MFSA to conduct investment services business.