In the years since the global financial crisis cast its long shadow over markets, countless commentators have predicted the next global downturn at every opportunity, in light of acute sovereign debt problems in the Eurozone, bubbly commodity and energy prices, and a balance-of-payments emergency in China. But these imbalances were relatively localized to specific sectors and regions, and as such, contained enough for the U.S. economy to keep the global cycle alive. Now, as the U.S. recovery begins to show its age, a recharged Europe and emerging markets are ready to take center stage.
We see the synchronized global growth of 2017 continuing in 2018. But momentum is shifting away from the United States for the first time during this cycle. Low inflation and, by extension, historically low interest rates should support global valuations, but overall returns should be more muted than in 2017.
Five key takeaways from our Private Bank Outlook 2018:
1. Leadership of global expansion is shifting outside the U.S. While U.S. growth should stay on track at just above 2%, most of the heavy lifting should come from secular growth in the tech-related parts of the economy, as well as cyclical growth abroad.
2. Europe and Japan have escaped stretches of stagnation, and above-trend growth can persist for some time. European corporate earnings started outperforming expectations in 2016, after a persistent run of disappointing numbers. In Japan, corporate estimate revisions have moved higher despite a strong yen. And unemployment rates in Europe and Japan are reaching their lowest points in at least a decade.
3. Emerging markets (EMs) will continue leading alongside Europe and Japan. The commodity-driven imbalances in EMs have largely corrected, and weaker EM currencies have restored trade competitiveness. EM inflation and policy rates have been broadly declining, and growth is now helped by better domestic demand. We do not expect a sudden slowdown in China to threaten the global economy. This global backdrop is far more constructive than it was a few years ago, when the United States was the world’s lone growth engine.
4. Yields may drift higher, but still along a very shallow rate cycle. Low unemployment, easier financial conditions and a modest inflation rebound should allow the U.S. Federal Reserve to hike policy rates three times in 2018, with little risk of faster policy rate normalization. We expect the 10-year Treasury yield to inch higher, but not much above 3%. Bond investors are focused on the longer-term secular decline in both trend growth and inflation.
In Europe, inflation and interest rates may take even longer to normalize. The European Central Bank should finish its bond-buying program in late 2018 before turning its attention to its first rate hike. The impact on European bond yields should be gradual and moderate, supporting a slow appreciation of the euro. However, Japan’s monetary policy may remain incredibly accommodative to reverse long-lived deflationary forces. The Bank of Japan should maintain strict control of the yield curve, exerting a moderate depreciation bias for the yen.
5. Continued low global yields are supportive for risk assets. Valuations across equities and credit seem elevated. Blame it on the yield environment. The cost of cash will remain low, short- and long-term. Equity valuations outside the United States look more desirable and, given a stable macro backdrop, should attract the marginal dollar of portfolio investment. But bear in mind: the higher valuations rise, the lower we expect future returns to be. Asset prices will find it increasingly difficult to rally faster than the overall pace of economic growth.
Read the full Private Bank Outlook 2018 here, including the risks to our view and a look at emerging disruptors.