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Macroeconomic Scenario for 2017-2018 : aligning timescales
Politics is a long game, the financial markets an extremely short one. The economy could be said to be somewhere in between. It is necessary to reconcile the durations of those three games to compose an economic and financial scenario that does not bring too much dissonance. In such a scenario the cycle will prosper, and even strengthen, provided that political risks do not materialise due to a draconian tightening of financial conditions.
The UK’s decision to leave the EU, Donald Trump’s election victory in the US and alternative election manifestoes offered to European voters – the political ambitions are great, the solutions radical, the narratives appealing. The exciting American story beguiled credulous markets and then dashed their hopes. Economic agents, and households in particular, seem more discerning. They know that some bitter medicine might have to be swallowed in the hope of actual improvements in terms of jobs and wages. The cycle will thus firm up ‘spontaneously’, with no fiscal stimuli but under the necessarily benevolent eye of the central banks.
A MORE SYNCHRONOUS FIRMING
The performances of the major economies and regions are not brilliant right across the board, but all are improving. Consumption is the powerful driver of this more synchronous firming, where a slight acceleration in inflation is not a threat. Households seem to be making trade-offs between job creation, wage growth, the cost of debt and inflation which, while limited, is expected to rise (an important point). Ultimately, though, they do not seem to be sacrificing anything.
However late-arriving, modest or unevenly distributed, investment is starting to help firm up the cycle. In addition, addressed demand from the front-running economies, including the United States, is providing support for those whose growth is less lively and less import-greedy, including the Eurozone.
The economic cycle is strengthening and prospering. In the UK and in the US, it seems to have absorbed the very real political shocks of the Brexit referendum and the result of the presidential election, respectively. In the Eurozone, it does not seem to have been altered by the imminence of make-or-break elections.
POLITICAL SHOCKS, FINANCIAL TREMORS, REAL "RESILIENCE"
Whether we’re talking about Brexit or, above all, the election of Donald Trump, recent political changes have undoubtedly been shocks. It is no longer simply a question of shifting the cursor of economic policy towards a little less state, less taxation and less social protection. Instead, the aim is to cure the ills of an ailing society by designating scapegoats and demonising the ‘rest of the world’ in particular.
The objectives are ambitious. Without its even being necessary to judge the effectiveness of the solutions proposed, suffice it to say that they are above all radical. So radical, paradoxically, that they are not materialising as rapidly as might be hoped by those betting on their effectiveness or as might be feared by those who consider them inappropriate and dangerous.
In the short term, the direct impact on the real economy and on agents’ behaviour is minor, because institutional obstacles must first be overcome and/or the assent of national parliaments obtained. The impact will be a knock-on effect. The recipes proffered are, of course, likely to affect agent expectations. Above all, though, they will exert a decisive and immediate influence on the markets.
Take Mr Trump’s election, for example. In addition to repealing the Affordable Care Act (ACA), the rather presumptuous “Make America Great Again” platform promises lower taxes as part of an ambitious tax reform, a sharp reduction in regulation to ‘liberate’ firms, the launch of a massive infrastructure programme and protectionist international trade policies.
The markets have indiscriminately bought into this bracing discourse. They threw themselves into the now infamous ‘reflation trade’, even though the timing, nature and scale of the expected fiscal stimulus were uncertain, if not unknown. Without even addressing the question of financing the stimulus, let alone questioning its scope and impact, its combination with the prospect of accelerating growth at the risk of a little additional inflation is a scenario that should strengthen the dollar and boost the equity markets, but one that will lead to higher interest rates.
Enthusiastic market speculation was largely quashed by a first setback. President Trump is struggling to unite the various factions of the Republican Party in order to complete the reform of the health bill due to replace the ACA. His room for manoeuvre is narrow: he has to satisfy the most radical Republicans, who feel that the proposed modifications are not bold enough, while trying not to alienate the more moderate lawmakers. That setback was also a negative sign of the administration’s ability to implement its programme.
The equity markets were not amused. The risk of tightening financial conditions was one that was mooted back in December. It is still on the agenda and justifies continued vigilance on the part of the US Federal Reserve.
A GRADUAL MONETARY TIGHTENING AND A MODEST RISE IN LONG-TERM RATES
The deployment of less accommodative monetary policies is a feature of the zeitgeist. The Fed set the ball rolling. However, monetary tightening is a far more perilous exercise than easing. The risks are not symmetrical. Even if justified by the cycle, depriving an economy and, most importantly, the financial markets of an ingredient of their success can only be effected very gradually (really very gradually).
Central banks have their eyes on the ball, therefore, and are withdrawing (or looking to withdraw) their monetary support bit by minuscule bit. They cannot take the risk of seeing long-term interest rates jump. Those rates are on an upward trend, but a very gentle one.
By Catherine Lebougre, Economic Research Department, Crédit Agricole S.A.
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