Tuesday, 3 January 2017

2017 Economic Outlook: Consensus and Other Views

It's time to look ahead to global macro prospects for 2017. I have posted similar outlooks for the past three years and followed up at the end of each year with an assessment of those forecasts. I assemble consensus views for the year ahead on global growth, inflation, interest rate and exchange rate outlooks which are presumably already built into market prices. The consensus view, as Howard Marks says, is "usually unhelpful at best and wrong at worst". What will move markets in 2017 is not the current consensus forecast, but the ways in which actual economic developments diverge from that consensus.

The big surprises of 2016 – Brexit, the impeachment of President Dilma Roussef in Brazil, and the election of Donald Trump as President – will have significant economic impacts in 2017 and beyond. 

The US equity market, as well as those of several other countries, has responded positively to Trump’s election. Investors have essentially placed bets that Trump’s early moves will focus on reducing taxes and regulations and that his campaign rhetoric about ripping up trade deals and deporting millions of illegal immigrants will proceed with caution.

Many high profile economists – Krugman, Roach, and Rosenberg – are warning of much more pessimistic outcomes (some of these views seem quite partisan). Some warnings take Trump’s election rhetoric on trade and immigration at face value. Others are based on the notion that Congress will not actually implement many of Trump's election promises.

Despite the market’s optimistic response and the aforementioned economists’ warnings, economic the consensus forecast has barely changed since before the US election. I do not think that means the election outcome will have little effect on economic and financial market performance in 2017 and beyond. I think it means that forecasters are a bit like deer in the headlights, not knowing yet which way to jump. The consensus remains unchanged as some forecasters shade their views in favor of the market’s optimism and others shade theirs in favor of the more pessimistic view. As I said in my review of 2016 forecasts last month, “2017 will undoubtedly once again see some large consensus forecast misses, as new surprises arise. As an era of rising asset values supercharged by ever-easier unconventional monetary policies seems to be coming to an end, the scope for new surprises to cause dramatic market moves has perhaps never been higher”.

With the foregoing in mind, here is what the consensus view is telling us about 2017:

  • Global real GDP growth is expected to be modestly stronger than 2016;
  • Global inflation is expected to be higher than in 2016;
  • The Fed is expected to hike the Fed Funds rate by 75 basis points, while other DM central banks are mostly expected to hold their policy rates steady and some EM central banks are expected to lower rates;
  • In the DM, 10-year government bond yields are expected to rise in the US, UK and Eurozone, but be little changed in Japan, Canada and Australia; In the EM, 10-year yields are expected to rise modestly in Brazil, Russia and Korea, but to fall in India, China and Mexico.
  • After strengthening against most of the currencies we track in 2016, the US dollar is expected to turn in a more mixed performance. Views of individual currency forecasters for 2017 exhibit much more dispersion than forecasts for other economic variables, but when averaged into a consensus view, most currencies are expected to move less than 2% against the USD. This seems like a very unlikely outcome. But for what it’s worth, the USD is expected to strengthen by the end of 2016 against RBL, BRL, CNY and CAD and to weaken against GBP, EUR, JPY, AUD, and MXN.
  • After strong performances in 2016, equity strategists tell us that US and Canadian stock markets are expected to post more modest gains of about 6% and 4%, respectively.

This year’s growth forecasts are notably more conservative than last year’s, as economists belatedly turn more cautious after several years of growth disappointing to the downside. Inflation once again is expected to move higher but, with the exception of the Fed, central banks are not expected to respond to higher inflation by tightening policy. 

Global Real GDP Growth Forecasts

Last year at this time, global growth was expected by the IMF to pick up to 3.5% in 2016 from 3.1% in 2015. Economists at five large global commercial bank expected a more modest acceleration to 3.4%. Instead, global growth is now estimated to have slowed to 3.0% in 2016.

This year, forecasters tell us once again that global growth will pick up in 2017 to 3.4% (IMF October forecast), or to 3.3% (OECD November forecast and the December average of global commercial bank forecasts).

Real GDP growth in 2017 is expected to be stronger in many economies, but with the notable exceptions of the Eurozone, UK, China, Korea and Mexico. Economies with the largest forecast growth pickups include India (7.3% in 2017 vs 6.7% in 2016), Canada (1.8% vs 1.3%), US (2.0% vs 1.6%), Japan (1.3% vs 1.0%), and Australia (2.7% vs 2.4%),. 

While global growth is expected to be stronger in 2017, an important divergence between DM and EM growth performance is expected to continue. EM growth is consistently higher than DM growth, but the important divergence is that, for a third consecutive year, DM economies (with the exception of the UK) are expected to grow at or above their trend rate of growth, while most EM economies (with the exception of India) are expected to grow below their trend rate. In the chart below, the blue bars show the 2017 consensus growth forecast versus the OECD estimate of the trend growth rate for each economy.

In 2017 the Eurozone and Japan are expected to grow at an above trend pace, while the UK – dealing with Brexit uncertainty – is expected to grow well below trend. In contrast, four of the larger EM economies are expected to grow well below trend: Mexico (1.0% below trend), Russia (0.9% below trend), Brazil (0.7% below trend) and China (0.5% below trend). 

In the chart above, the red bars show the latest OECD composite leading indicators (CLIs) versus trend for each of the economies. Unlike in the past two years, these CLIs generally support stronger 2017 growth than economists are forecasting, with a few exceptions.

In the DM economies, the leading indicators suggest that growth could surprise on the strong side in the Eurozone and Canada but on the downside in the US and Japan. In the EM economies, CLIs suggest that growth could be stronger than expected in Brazil, India, Russia and Korea but weaker than expected in China.

Global Inflation Forecasts

Global inflation has consistently fallen short of expectations since 2013. This occurred in spite of unprecedented efforts by central banks to fight disinflation.

A year ago, global inflation for the entire set of world economies was expected by the IMF to move up to 3.5% by the end of 2016 from 2.9% at the end of 2015. By October 2015, the IMF had cut its year-end 2016 global inflation forecast to 3.2%. Meanwhile, a year ago, global commercial bank economists expected weighted average inflation for 12 major economies we track to move up to 2.3% in 4Q16 from 2.0% in 4Q15. Instead, inflation for these countries remained flat at 2.0% in 4Q16. For 2017, the Bloomberg consensus of economists forecasts that weighted average inflation for the 12 countries will rise to 2.5% in 4Q17. The IMF and the OECD expect a slightly bigger acceleration for the 12 countries to 2.6%.

These forecasts, most of them made between mid-November and early-December, may already subject to upward revision. Crude oil prices ranged from $45 to $49 per barrel during the period these forecasts. Since then, in the wake of the December OPEC meeting, the price has risen to $54/bbl in late December and looks likely to maintain the higher price into early 2017.

In all of the DM economies we track, inflation is expected to rise. In EM economies the picture is more mixed, with inflation expected to fall in Brazil and Russia, where currencies have strengthened markedly over the past year. In Mexico and China, where currencies have weakened, inflation is expected to rise. Considerable slack remains in the global economy, especially in EM economies. But wage growth is picking up in some countries. Commodity prices are rising. Inflation expectations are rising.

Non-Consensus Views

As already mentioned, some economists, who are not part of the consensus, have a much darker view of 2016 prospects. Paul Krugman and Stephen Roach warn that Trump will set off trade wars with China, Mexico and other US trade partners. Krugman says, “Will this cause a global recession? Probably not … What the coming trade war will do is cause a lot of disruption … and quite a few American manufacturing operations would end up being big losers.”

Russell Napier sees a different problem with the consensus: 
The consensus may be bullish on the USD exchange rate and while consensus is regularly wrong, on this occasion it might be wrong because it is not bullish enough! 

Napier argues that “the USD has much, much further to rise” and that this will present a particularly difficult environment for China, which is also one of the major targets of Trump’s protectionist rhetoric. Rising US interest rates have spilled over globally and have aggravated China’s capital flight and accelerated the decline in China’s foreign exchange reserves. Napier suggests that it is “time for China to grow up and run an independent monetary policy choosing the appropriate price or supply or money without reference to the level of the exchange rate.” A strengthening USD and a depreciating CNY are “turning the deflationary screws on the global economy. It will likely be up to the Fed to stop the rise of the US dollar, but what ammunition is at its disposal, particularly if the President’s fiscal policy is indeed stoking domestic inflation?”

David Rosenberg graciously offered up a free year-end piece, which the Globe and Mail ran with the headline: "Forget inflation - here's what really will happen in 2017". The headline is a bit misleading because Rosenberg, quite reasonably, says “I actually find it senseless to provide a forecast for the entire year ahead at this time”. While declining to provide a forecast, Rosenberg is pretty sure about one thing: “I do have as strong view that inflation very much is going to be the non-event it has for the past several decades”. Rosenberg provides several good reasons why Trump’s platform will be disinflationary. Although bond yields will be volatile over the course of 2017, Rosenberg thinks that as inflation fears abate, the 10-year US Treasury yield will fall and "close the year around 2%", about 70 basis points lower than the consensus forecast. 

Another non-consensus view is that of Wall Street’s number one ranked strategist, Francois Trahan, Head of Portfolio Strategy at Cornerstone Macro. In this video Trahan goes against the consensus with a view that the equity bull market is almost over and it’s time to get defensive. He makes this argument partly on the assumption that Congress will not pass all of Trump’s pro-growth policies and their effect will be delayed but, more importantly, because US monetary policy is tightening, global financial conditions are tightening, and growth is about to slow significantly. He argues that macro policy forces already in the pipeline will outweigh anything Trump does in 2017 and the result will be lower US corporate earnings and a lower P/E ratio, so that the slowdown will have a disproportional impact of equity prices. Trahan expects US data to weaken in 1H17 after a burst of strength in late 2016. The result will be a significant correction and possibly a bear market in equities. I have to give Trahan credit; he has the conviction to go against the frozen Wall Street consensus.   

I'm not suggesting that we should toss out the consensus forecast; it provides a useful benchmark against which to measure the coming surprises of 2017. But, as with other non-consensus analysts, I am suggesting that once again we should apply a hefty discount rate to the consensus and consider the risks around a wide range of possible optimistic and pessimistic scenarios. 

Questions and Conclusions

2016 turned out to be another year in which global growth and inflation were both modestly disappointing and the political surprises were widely viewed in a negative light. Risk assets nevertheless performed very well. The legacy of the political surprises of 2016 is policy uncertainty for 2017. Some of the unanswered questions include: 

  • How will the UK and the EU handle Brexit? And will other EU countries follow the UK's lead? 
  • Which of Trump’s election promises will be implemented and when? 
  • How will US trading partners respond to Trump’s protectionism? 
  • How will global markets react and adjust to expected Fed tightening? 
  • Will the expected continued strengthening of the US dollar combined with below trend growth in China, Brazil and Russia create financial instability and continue to exert global deflationary pressures? 

At the moment, I would be quite suspicious of the advice being offered by many investment strategists. Those who have been long the growth trade and have benefited from the “Trump rally” in equity markets are suggesting stay with the trade in the near term but be flexible and prepared to exit should the recent optimism be blunted by disappointments. Those strategists who went into the US election in a defensive position and remain skeptical that Trump’s policies can “Make America Great Again” are suggesting maintaining larger than normal cash positions which may be deployed when risk assets correct sometime in 2017. 

In 2017, I’m afraid, we are on our own.
Ted Carmichael is Founding Partner of Ted Carmichael Global Macro. Previously, he held positions as Chief Canadian Economist with JP Morgan Canada and Managing Director, Global Macro Portfolio, OMERS Capital Markets. 

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