For the quarter ended June 2017
Discomfort with asset prices and the inability of President Trump to implement policy change has translated to increased calls for an imminent financial market correction. The economic cycle however remains robust and many of the geopolitical risks expected earlier this year have not eventuated.
The length of the current expansion has also been highlighted as an indication that a correction is overdue. However, expansion duration has never been the reason for the end. Accordingly with none of the signals of a recession appearing imminent (inflation risks, macro-economic imbalances or external shocks) a “no boom, no bust” outcome remains the most likely outcome.
The current consolidation phase (with growth in the first half of 2017 slower than anticipated) is expected to strengthen, with the US economy poised to accelerate in the second half of the year. China’s slowdown is seen as controllable and Europe is continuing to improve.
This is clearly shown by the positive forecast revisions for Gross Domestic Product (GDP) growth in Advanced Economies.
Source: Forsyth Barr analysis, International Monetary Fund
At the start of the year we could have pointed to the heightened political risks in Europe, risks arising from the United Kingdom exiting the European Union, credit issues in China and any number of other geopolitical risks. Well, the European elections went off without a hitch and the main issue has been the United Kingdom. The snap election undertaken by the May government was supposed to deliver greater stability, however the outcome has been more reliance on other parties and the opposite of what had been hoped.
The other major variance from expectations has been President Trump and his inability to deliver on almost anything. The result is that the fiscal stimulus built into interest rate forecasts and inflation targets has been pared back. However, the United States economy was improving prior to these promised measures and even without this stimulus, growth continues to improve.
The equity markets we follow all delivered positive local currency returns over the last three months. However, the strengthening New Zealand Dollar (NZD), buoyed by positive Terms of Trade and still robust economic growth, offset many of these gains.
European markets led international market returns, benefiting from the improving outlook and from political risks abating. US equity returns were strong in local currency terms, with nine of the 11 sectors advancing; just Energy and Telecommunications declining. This was despite the political issues surrounding President Trump and reinforces the underlying growth in the US economy. It also suggests business is getting on with business, rather than focusing on political noise.
Australian returns were impacted by declines amongst telecommunications companies, the Australian Budget introducing another levy on the largest five banks and by weaker oil prices impacting the Energy sector. A number of Consumer Discretionary companies were also downgraded, as the impact of the entry of Amazon into the Australian market weighed on sentiment.
Domestically, New Zealand equities produced solid positive returns. Defensive sectors benefited from declining interest rates. Building company downgrades acted as a brake on returns, with higher building costs and tighter lending criteria pressuring margins and expected activity levels.
Source: Forsyth Barr analysis, Bloomberg
Long-term interest rates fell during the quarter as financial markets discounted the degree of stimulus that would occur in the United States. The United States Federal Reserve however has maintained its tightening of monetary policy plan, believing the slower than expected growth in the first six months of 2017 to be transitory.
Higher long-term interest rates are still expected, driven by global economic strength and a gradual pull-back from quantitative easing measures in Europe later this year. The United States Federal Reserve is also expected to begin reducing its balance sheet. However the speed and quantum of the rise is likely to have moderated, given weaker inflation expectations.
New Zealand interest rates should follow global trends, although the Reserve Bank of New Zealand is expected to maintain the Official Cash Rate steady at 1.75% until well into 2018.
* 25 bp (basis points) is equivalent to 0.25%