Standish’s Leduc: Hazards remain
With lower-than-expected growth and stronger-than-expected inflation, David Leduc, chief investment officer at Standish, a BNY Mellon company, ponders the challenges ahead as we reach the mid-point of the year.
At the prediction at the beginning of the year our expectation was for a further divergence in monetary policy between the G-4 central banks with the US Federal Reserve (Fed) and the Bank of England (BoE) reducing the level of accommodation, while the Bank of Japan and the European Central Bank (ECB) did the opposite.
We thought that this would be supportive of the US dollar, particularly against the Japanese yen and the Canadian dollar.
Although our expectation for monetary policy was correct, the US currency’s performance in 2014 has been mixed. The US dollar has strengthened against the Canadian dollar, but it weakened versus the yen.
The dollar is also slightly stronger versus the euro following the ECB’s decision to lower its deposit rate into negative territory and intensify the preparatory work for its proposed purchases of asset backed securities at its June meeting.
Overall, the broad trade weighted dollar is up 0.5% in nominal terms as of mid-June. We believe that stronger US economic growth and rising inflation expectations will lead to further dollar strength in the second half of the year as investors begin pricing in interest rate hikes by the Fed by the middle of 2015.
Although Eastern Europe has been bolstered by the strong German economy, the crisis in Russia and Ukraine has weighed on growth in the region.
Economic activity in Developing Asia has been undermined by a combination of weak global demand, political turmoil in Thailand and the ongoing correction in the property sector in China.
Latin America has struggled with lower commodity prices and tighter monetary policy in high inflation countries such as Brazil.
Despite the poor start to 2014, we continue to expect a resynchronisation of global growth as the recovery in developed markets begins to filter through to emerging markets economies in the coming quarters.
High frequency indicators already suggest a rebound is underway in the US, following a weather related drag during the winter months. In addition, the recent monetary easing by the European Central Bank and lower sovereign borrowing costs in peripheral Europe have lessened systemic risk in the eurozone and raised growth prospects for later this year.
Finally, sounder macroeconomic policies and structural reforms in some emerging markets have boosted investor confidence and helped reverse the capital outflows that began when the Fed first announced its intention to taper quantitative easing in May 2013.
Therefore, we have only shaved three-tenths off our global GDP forecast leaving us at 3.3% for this year and 3.7% in 2015. By contrast, we have raised our global inflation forecast slightly to 3.7% this year and 3.4% in 2015, but this masks considerable differences in price pressures below the surface in both developed markets and emerging markets.
We continue to believe a pick-up in emerging markets growth will benefit the performance of local currency debt, but the strength of the recent rebound in these markets suggests investors will need to be more discriminating about where they put their money going forward.
We also still expect that the combination of faster US economic growth and a reduced level of accommodation from the Fed will result in higher US Treasury yields and a stronger US dollar.
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