From the opening salvos of a trade war to a flattening US yield curve, a relatively benign economic outlook has given way to a more complex economic picture for investors. In the following insight, Adrien Pichoud, portfolio manager and chief economist at SYZ Asset Management, explores seven charts to offer a clearer perspective on key economic trends, flashpoints, and sovereign re-ratings shaping the global outlook.
Inflation increase could lift US yield curve
The Fed’s continued monetary policy normalisation implies higher real yield, especially in the short end, and less upward pressure on the long end of the curve. This points towards the US yield curve continuing to flatten, as long as there is no inflation regime change.
Short-term rates have risen more rapidly than long-term rates and the difference has narrowed to an all-time low of 47bps.
Since last September, the acceleration in the Fed’s monetary policy normalisation, coupled more recently with the rising unpredictability of the outlook for global growth, other hawkish central bank interventions and the uncertainty surrounding Jerome Powell’s intentions for Fed policy, contributed to this spread-narrowing trend.
Moreover, economic data in the US remains strong, particularly in the manufacturing world, but also on the job front. The only missing piece in the equation is inflation, which continues to progress at a mild level. This lack of long-term inflationary pressures has kept a lid on the long end of the curve.
Trump’s talent lies in improving expectations
Donald Trump may be good at improving consumer sentiment, but he has not succeeded so far in spurring actual consumption. This is the crude conclusion drawn from the disconnect in the past 18 months between consumer optimism, close to historical highs, and real consumer spending, growing at a stable rate since 2016.
The surge in household expectations had been initially driven by enthusiasm about the tax cut package promised by candidate Trump. Expectations of rising wages in a context of low unemployment may have helped too. However, higher energy prices and the lack of significant wage increases instead depressed the real purchasing power of US households in 2017, forcing them to dig into their savings to simply sustain consumption growth.
This may change once households effectively receive the tax rebate cheque – even if part of that rebate may not be spent and rather used to replenish depleted savings. In any case, it is difficult to imagine consumption accelerating as strongly as confidence indicators suggest. But sentiment may matter most to Trump ahead of the mid-term elections and on that side he seems to be doing just fine.
Glass more than half full for transitioning Eurozone
When transitioning from acceleration to cruising speed, economies can often give off the unwarranted feeling of a slowdown. The Eurozone may be going through one of these phases in early 2018.
All real-time indicators of activity and sentiment are coming down from highs reached at the turn of the year. However, objectively, the glass is still much more than half full for the Eurozone growth picture. The near-3% pace of annual expansion reached at the end of last year was never going to be sustainable and economic data still points toward an annualised pace of expansion of around 2%, a fairly strong growth rate from an historical perspective.
But investors’ psychology is such that, in this context, it is focused on the empty part of a previously-full glass. The streak of disappointing economic data, including softer inflation data, has taken off some of Europe’s economic shine. On the other hand, it has moderated expectations around the ECB’s monetary policy normalisation, taking off some upward pressure on the euro and European rates. This may facilitate the transition towards a stabilised mid-cycle growth rate – less spectacular, but still enough to drive unemployment lower and fuel corporate earnings’ growth.
Yuan strength contradicts currency manipulation theory
In March, the Chinese yuan extended its appreciation against the US dollar, to end within close range of its pre-2015 devaluation level. If this was not related to the modest rate hike announced by the People’s Bank of China in the wake of the Fed’s progress towards normalisation, the continuation of supportive activity data may have contributed, but is unlikely to have been the decisive factor.
The recent strength of the Chinese currency has probably more to do with the government managing to stem the capital haemorrhage that started in 2014. This forced the infamous August 2015 FX regime change and a host of specific measures designed to clamp down on capital outflows from the mainland. Those outflows also drove a 15% depreciation of the yuan against the US dollar in three years.
With capital flows returning into positive territory, fuelled by the Chinese trade surplus, downward pressure on the currency has abated since 2017. Yuan strength has weakened the case for the US administration to label China a currency manipulator. However, the irony is now that the US has announced tariffs, China is purported to be considering devaluation strategies.
Even though the geopolitical situation in the country and the region remains fragile, this high growth regime came on the back of very high consumer and government spending. This diminishes the negative political and economic effects of the failed military coup in 2016.
According to fourth quarter growth figures, Turkey’s GDP print was at 7.3%, the highest in the G20 bloc, but down on a very strong third quarter from 11.3%.
This level of growth does not come without risk. The economy is overheating and has some large imbalances: double-digit inflation and a ballooning current account deficit, both of which are reflected in a weak currency – the lira is down 13.9% since the end of August against the US dollar.
This context led Moody’s to downgrade Turkey’s credit rating to junk status last month.
Recovering Spain rewarded by S&P upgrade
The high uncertainty induced by the controversial Catalonian referendum seems to be a thing of the past for the Spanish economy, after its 10-year bond yield dipped to 1.16%. The country benefitted from an upgrade of its sovereign ratings, as well as from a revision of its economic outlook.
Indeed, the Bank of Spain has revised its forecast for economic growth higher, projecting 2.7% growth for this year, up from the 2.3% previously expected. Political uncertainty has somewhat eased in Catalonia which, combined with a robust external sector, an improved labour market and a healthy global economic climate, should help to sustain the country’s growth. The latest decision from the credit rating agency S&P to raise Spain’s rating to A- also supports a brightening outlook for the economy.
Despite the fact that Spain is expected to grow at a slower pace this year (2.7% vs 3.1% last year), this upgrade remains a positive sign for Europe, especially when economic uncertainty persists in Italy.
Metal measures: trade war reflected in copper/gold ratio
Despite solid economic data, fears of a trade war have materialised in metal prices with copper put under pressure. The copper/gold ratio is seen as a barometer of economic health, as prices for the red metal tend to increase during periods of robust global growth, while gold usually benefits from a risk-off environment and rising geopolitical tensions.
The ratio jumped following the US presidential election, as copper benefited from Trump’s pro-business agenda with expectations of tax cuts and infrastructure spending.
Recently, the prospect of a trade war has dominated the headlines, especially with President Trump’s willingness to impose tariffs on $100bn of Chinese imports.
Hence, the ratio has gone down since the beginning of the year, with copper posting the first quarterly decline, falling by 8.7% since Trump’s election in November 2016, while gold ended the quarter in positive territory, gaining 1.7%.
Adrien Pichoud, portfolio manager and chief economist at SYZ Asset Management