To date, 2018 is turning out to be a very interesting year in terms of economics, financial markets and politics, but there is a remarkable sense of calm in financial markets.
On the economic front the very strong momentum evident during 2017 has undoubtedly experienced a bit of a speed wobble. Growth virtually everywhere has softened, and the most common question now being asked is if this is the beginning of a protracted slowdown or just a pause for breath after a very strong rebound. The answer is probably different in different jurisdictions.
In the Euro Zone, economic activity expanded by 0.4% in the first quarter, down from a very robust rate of 0.7% in the previous quarter. The annual growth rate in the first quarter slowed to 2.5% from 2.8%. This still represents a solid rate of growth for the Euro Zone, but nevertheless it does signify an easing of growth momentum. There are temporary factors at play such as poor weather, strikes in Germany, a strong euro over a protracted period, and concerns about the growth of protectionism. Of a less temporary nature, it is likely that there is now less spare capacity after such a relatively strong economic rebound. Although the unemployment rate still stands at 8.5%, the employment rate amongst those aged between 20 and 64 years of age reached 72.2% in the EU late last year, which is the highest rate ever achieved. The bottom line is that the Euro Zone is not likely to be embarking on a worrying slowdown of growth, but 2018 and 2019 look unlikely to repeat the stellar growth rates of 2017.
In the UK in contrast, the annual growth rate slowed to 1.2% in the first quarter, which compares to 2.1% in the first quarter of 2017. Indeed, the Governor of the Bank of England recently suggested that Brexit has halved UK growth. No surprises there as Brexit does represent the most profound event of uncertainty seen in generations. Unfortunately, we are no closer to a solution to the conundrum today than in the immediate aftermath of the referendum almost two years ago. However, we are considerably closer to the exit date of 29th March 2019. The divisions within UK politics on both sides of the political divide are as gaping today as they ever were and the outcome of the current farce is still as unclear as it ever was.
In the US, GDP growth slowed to 2.3% in the first quarter, but the majority of economic indicators are still looking very solid, particularly the labour market, which has seen the unemployment rate fall to just 3.9% of the labour force. Consumer confidence and business surveys also continue to look very solid.
The only incident of note in the emerging world is the renewal of serious problems in Argentina.The Argentinian authorities are struggling in the face of a collapsing currency and massive capital outflows. Interest rates have been taken up to 40% and the assistance of the IMF has been sought. Argentina is an abject lesson in the long-term legacy of debt default. A few short years ago many populist voices in this country were calling for debt default and often cited Argentina as a template to follow. I don’t think so.
The only good thing at the moment is that the Argentinian problems are being confined to Argentina and contagion is still thankfully not evident.
On the interest rate front, it is clear that the US rate cycle will continue to move in a firm upward direction over the coming months, while the Bank of England is not likely to be in any hurry to tighten monetary policy any further. I have argued for some time that if the growth momentum evident in the Euro Zone in 2017 persisted for much longer, the European Central Bank (ECB) could start to get somewhat less relaxed and once the bond-buying programme (QE) ended this Autumn, higher interest rates could follow in 2019. This view of the world is starting to look somewhat alarmist and the obvious sense of relaxation in the ECB looks set to last for the foreseeable future. The ECB will obviously move at some stage to bring official interest rates back towards normality, but if the current modest softening of economic activity persists over the coming months, the ECB will not be in any rush to change course on official interest rates. Importantly, inflationary pressures are conspicuous by their absence. The headline rate in April is expected to decline to 1.2% and it is showing no sign of coming anywhere close to the ECB’s threshold of 2%.
In October, Mario Draghi will step down after eight years at the helm of the ECB and he will now almost certainly do so without ever having to increase interest rates. What happens after he steps down will be more interesting. The current favourite to succeed Draghi is Jens Weidmann, the current German representative on the ECB Governing Council. As a Bundesbank member, one would expect Weidmann to be less comfortable with current artificial monetary policy conditions than his predecessor. This will be one to watch, but for the moment, there is little for Irish borrowers to be terribly concerned about.
On the political front, the North Korean situation has calmed in dramatic fashion; Iran has come centre stage following the US withdrawal from the international nuclear deal with that country and the re-imposition of trade sanctions; Palestine is boiling up; and the Russian issue is still bubbling under the surface. All in all, not too much of major concern at the moment, but the Iranian situation has the potential to exert more upward pressure on oil prices. This would obviously fuel headline inflation, but the negative impact on global growth would probably weigh heavier on the minds and actions of central bankers.
As we approach the middle of May, a year that promised considerable turmoil on markets, has actually turned relatively calm in the second quarter. We have obviously seen considerably more volatility on equity markets, but they are still holding up remarkably well. In the year to May 14th, the S&P 500 is up 2%; the Dow Jones is up 0.5%; the FTSE 100 is up 0.3%; the German DAX is up 0.3%; the French CAC is up 4.1%; the NIKKEI is up 0.4%; and the ISEQ has shed 1.4%. Within these overall changes, there has been a relatively high level of volatility, but certainly no sense of panic.
On bond markets, the US 10-year yield briefly went over the key 3% level, with no real consequences. It is currently trading under that key level, but bond markets look very relaxed. The German 10-year is still trading at a low 0.59% and the Irish 10-year is just under 1%.
Markets are still remarkably calm in general and not being fazed by anything thrown at them. The ongoing big challenge will be the ending of Quantitative Easing (QE) in the Euro Zone in the autumn, and the gradual unwinding in every jurisdiction.
All in all, the world is characterised by a sense of calm at the moment.
The views and opinions expressed in this article are those of the author.
Originally published on www.friendsfirst.ie May 2018