Todd Mattina, Chief Economist and Strategist on the Mackenzie Asset Allocation Team, discusses the global reflation trade, the outlook for the global economy and the potential tightening of interest rates.
Outlook Q3 2017 with Todd Mattina
Todd Mattina, Chief Economist and Strategist on the Mackenzie Asset Allocation Team, discusses the global reflation trade and recent market developments.
TODD MATTINA: As the highwater mark for the global reflation trade moves further into the rear view mirror, global markets and the economy appear to be shifting gears. Three pillars have been driving global reflation since mid-2016 including a strong uptick in global manufacturing activity and world trade, stronger business and consumer confidence and the surprise election of Donald Trump, with high expectations on his agenda of deep tax cuts, infrastructure spending and deregulation; however, the global reflation trade peaked in December and has really faded since that time, as the influence of these three pillars has begun to fade. Three factors appear to be at play. First, China has been gradually tightening its macroeconomic policies, dialing back an unsustainable pace of debt accumulation, moderating its positive impact on commodity prices and global trade going forward. Second, the momentum in the US economy has slowed in the first quarter and third, the chaotic White House has been unable to advance its pro-growth agenda of deep tax cuts in the Republican-controlled Congress, raising questions about the timetable and size of measures that can be feasibly implemented.
Looking ahead, the global economy is shifting into a new phase of stable and steady growth with low inflation compared to the previous phase of rapid reflation and growth since 2016. Steady growth and low inflation provides a bullish backdrop for risk assets. As a result, we’re tactically overweight stocks relative to government bonds, as we see equities as being well compensated over risk-free assets in this type of macro environment. In terms of relative equity markets, we’re underweight the US stock market because we see investors reassessing the cyclical and policy outlook in the US, relative to international markets with better relative valuations including the UK and emerging markets.
The main uncertainty is the increasingly hawkish tone taken by the world’s major central banks despite sluggish underlying inflation and wage data. The Fed anticipates two rate hikes this year and next while reducing its $4.5 trillion balance sheet to unwind the effects of quantitative easing. Mario Draghi also increased uncertainty about potential ECB tightening later this year, when he flagged that deflationary risks have been replaced by reflationary ones in the Eurozone. The Bank of England and the Bank of Canada also surprised markets with more optimistic outlooks and hawkish rate overtures; however, I believe that premature tightening and real interest rates around the world risk slowing the global expansion and for this reason I believe central banks will move very cautiously in raising rates, keeping a close eye on incoming macroeconomic data this quarter, as well as closely monitoring signs of excessive financial exuberance and asset markets.
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- Global markets and the economy appear to be shifting gears following the peak of the global reflation trade in December 2016.
- Steady growth and low inflation provide a bullish backdrop for risk assets.
- Central banks will raise rates cautiously to avoid slowing down the global expansion.