2016: a retrospective
What a year that was. Looking back now, 2016 seems like the year during which the world appeared likely to end on a number of occasions, but didn’t.
The year started badly. January saw sharp market falls as investors worried about slower global growth and the risks of deflation. Economists were trying to out-do themselves by picking the highest probability of a US recession without actually forecasting one. And fears of a hard-landing in China bubbled to the surface…yet again.
By the end of the year global growth looks likely to have come in at around the same level as 2015, and headline inflation is moving higher in many of the key developed economies including the US, UK, Eurozone and Japan. The combination of okay growth and rising headline inflation saw a reduction in deflation fears, resulting in sharply higher bond yields as we head into the end of the year.
The rise in headline inflation is in large part due to base effects, or more precisely low numbers from last year which captured the fall in commodity prices, falling out of the annual calculations. At the end of the year rising commodity prices are giving this a bit of assistance. However, outside the US, core inflationary pressures remain subdued.
Despite the subdued nature of core inflation, central bankers were becoming more concerned about the risks of prolonged periods of aggressive monetary policy easing. That came with a growing recognition that monetary policy was at the limits of it efficacy. This combination of factors resulted in the European Central Bank extending its asset purchase programme beyond the previously scheduled end of March 2017, but reducing the quantum of purchases by a quarter.
Part of the ‘wall of worry’ at the start of the year was that the US Federal Reserve (the Fed) would just blindly raise interest rates the four times they signalled at the end of 2015, and be wrong. In the end, the Fed listened and, despite a brief flirtation with the idea of a rate rise mid-year, only managed to squeak one in right at the end of the year.
Markets were more well-disposed towards Fed rate hikes by the end of the year. This has been a shift from thinking of rate rises as a significant risk to the growth outlook, to this now being a good news story, in that the US and global economies are now more resilient to the normalisation of US interest rates.
Contrary to constant speculation, the Chinese economy survived 2016. Indeed, some of the activity data was turning up at the end of the year while key inflation data (producer prices) moved from deflation to inflation as the year progressed. That said, efforts to stabilise the economy have come at a cost. Debt is higher and there is a bubble forming in the residential housing market. But none of these are new issues for China and we continue to believe the risks are manageable.
Of course politics was also to the fore in 2016 as Britain voted to leave the European Union and the United States elected Donald Trump its 45th President. These outcomes were a wake-up call to the political establishment everywhere that people are grumpy about lack of economic progress and worried about job security, and are prepared to vent their concerns against the establishment at the ballot box.
The market reaction to Brexit was violent, only to recover quickly as markets realised nothing would change any time soon. The reaction to the Trump victory took a lesson from that and despite early weakness on the day, markets responded in a somewhat more sophisticated manner. The focus quickly moved to the positive aspects of a Trump policy platform (new infrastructure spending, tax cuts, deregulation) that would be good for growth and, importantly, reflationary.
Could this prove the genesis of the rotation from monetary to fiscal policy? We have long argued that it was time for fiscal policy to pick up the baton from monetary policy and lead the charge in boosting domestic demand in countries still suffering significant output gaps and persistently low inflation. The US is the country that arguably needs this least as the Fed gets ever closer to achieving its dual mandate, but is hopefully a lightning-rod in countries/regions where fiscal policy needs to step up. In the meantime, markets have parked the more worrying aspects of Mr Trump’s policies, and in particular his anti-trade stance, so there is a risk the positive reaction thus far turns to the negative as more details emerge.
But the biggest political surprise was the one at home with John Key standing down after 10 years leading the National Party and eight years as Prime Minister. Bill English was duly installed as New Zealand’s 39th Prime Minister and will lead the Government into the 2017 election.
The New Zealand economy had another strong year with growth at 3.6% (year to September). Inflation remains lower than desired but will soon move higher as the same base effects impacting inflation in other countries appears likely to see New Zealand headline inflation back into the bottom-end of the Reserve Bank’s target band. We end the year with the Official Cash Rate at 1.75%, a level we expect will be the low point for the cycle.
Source: RBNZ and AMP Capital
In the end, 2016 ended up being a year that proved the resilience of markets once again, albeit with bouts of angst and volatility. After all the January worries, and the Brexit and Trump electoral wins, markets ended up having an okay year. In fact, key asset classes are finishing the year (albeit with a few days still to go) not far off their long-run expectations. Developed market equities (in local currency) are up 9.5%, emerging markets (in local currency) up 8.9%, New Zealand equities up 6.9% and global bonds (hedged into NZD) up 4.8%. 2016 will prove a good example for the future about why not to get caught up in the noise but keep focused on longer-term goals.
No doubt there will be more noise next year. For a start, there are more elections to watch (the Netherlands, France, Germany, New Zealand). There will be new chapters in the Brexit saga and tussles between countries over trade and market access. From an economic perspective we expect slightly higher global growth and higher inflation. In that environment key points of interest will be how quickly the Fed raises rates and the subsequent impact on the US dollar and dollar-sensitive asset classes. The evolution of ‘Trumponomics’ will also be keenly watched.
But let’s not worry about that too much just yet – it’s time for a well-earned break. Have a great Christmas and New Year and we will be back with our outlook for 2017 in the January edition of Quarterly Strategic Outlook and the summer issue of Taking Stock.
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