State of the Global Economy

Global growth sputtered along at about 3% for 2016. After another year of disappointing economic expansion, could there be a catalyst in 2017? Are tax cut and infrastructure spending promises made by US President Donald Trump enough to jump-start the global economy? Could stabilizing commodity prices propel emerging markets? Or will geopolitical risks cause a slowdown?

A chief economist, market strategist, and research analyst from across Natixis Investment Managers take a look at growth accelerators and deflators around the globe, and their implications for markets and portfolios.
 

Our Panel Responses

David Lafferty
David Lafferty, CFA®

Senior Vice President and Chief Market Strategist Natixis Investment Managers — US Distribution

The global economy is showing nascent signs of improvement. In the U.S., we estimate that real GDP will have accelerated from just over 1% annualized in the first half of 2016 to over 2.5% in the second half. This is before the Trump Trifecta of infrastructure spending, lower tax rates, and deregulation potentially kicks in. All of these, to varying degrees, should put upward pressure on real U.S. growth in 2017.

However, investors shouldn’t become overly optimistic. Most of the benefits to any infrastructure program will occur after 2017. They may also be limited by fiscal pressure coming from Congress, or provide only a short-term boost if not designed to improve long-term productivity. Lower personal tax rates should increase consumption but will also be constrained by deficit hawks. Lower corporate tax rates and discounted repatriation of foreign earnings should bolster capital expenditures, but these cuts may be partially offset by repealing other corporate deductions.

Activity in Europe picking up
Outside the U.S., growth is also beginning to slowly pick up steam. Activity measures across continental Europe are improving, while the UK has yet to feel any significant economic pain from the Brexit vote (with the emphasis on “yet”). After stumbling a bit, growth in China appears to have stabilized for the near term while policymakers wrestle with the trade-offs between economic reform and excessive credit expansion.

Better growth prospects for China and EM
China’s stabilization has in turn heightened growth prospects for emerging markets in general, compounded by the rebound in commodity prices. While the overall outlook for growth globally is improving, the underlying supply-side constraints remain in place. These include economies saddled with excessive debt, poor labor demographics, and stagnant productivity. Most importantly, stronger growth is likely to come with increased inflationary pressure which will put central banks on greater notice. Too much inflation could push up nominal rates further out the yield curve while policy accommodation wanes at the short end. The macro landscape is set to improve, but investors should expect the “Trump Train” to pull out of the station very slowly.

Modestly stronger global growth should create improving fundamentals for risk assets like stocks and corporate bonds of all types. These improving fundamentals will only partially translate into higher prices, as valuation has become more of a headwind in these sectors. High-quality sovereign and agency debt will remain under pressure, although we believe bond yields will rise only modestly. The U.S. dollar may strengthen, but less than current consensus, as the 30% jump in the greenback since mid-’14 already reflects the known policy divergence of central banks.

Geopolitical risks are looming
While we expect modest improvement in the global economy and reasonable (if unspectacular) returns for risk assets, this belies an even larger shift in geopolitical and market risks. The new and inexperienced Trump administration will be tested on multiple fronts including Russia and China. Brexit negotiations are shaping up to be ugly while elections in France and Germany will test the long-term viability of the euro zone. Syria and Turkey remained mired in crisis. Investors would be wise to recognize that short-term volatility often overpowers improving fundamentals. This burgeoning uncertainty represents an opportunity for true long-term investors, but is likely to cause heartache for the more risk-averse.
David Lafferty, CFA®, is a Senior Vice President and Chief Market Strategist at Natixis Investment Managers — US Distribution.

David Lafferty is Senior Vice President and Chief Market Strategist at Natixis Investment Managers. He is responsible for assessing economic and capital market trends and their implications for investment portfolios. His team also works with affiliated asset managers to develop portfolio insights. He has been with Natixis since 2004. Previously, Mr. Lafferty was senior vice president responsible for fixed-income and asset allocation products at State Street Research & Management, developing investment strategies for institutional clients with assets ranging from $10 million to $2 billion. From 1998 to 2001, he was a senior investment strategist at MetLife, structuring asset allocation programs for institutional clients with assets totaling $600 million. From 2008 to 2012, he served on the Board of Directors of Caspian Capital Management/Caspian Private Equity, a New York based hedge fund and private equity firm.

Mr. Lafferty is a frequent speaker at industry events and is often quoted in Barron’s, Bloomberg, The Wall Street Journal and other financial publications. He received his BA from the University of New Hampshire and his MSF (Master of Science in Finance) from Suffolk University. He is a member of the Boston Security Analyst Society, the CFA Institute, and the National Association for Business Economics (NABE) and has more than 20 years of investment industry experience.

Gregory Hadjian
Gregory Hadjian

Macro Research Analyst Loomis, Sayles & Company

We are modestly optimistic about the outlook for the global economy in 2017. The negative shock from the collapse in commodity prices has dissipated, policy measures have supported growth in China for now, and two major political events in developed markets, the Brexit vote and the U.S. presidential election, have passed, even if the implications remain unclear.

Uptick in global growth
We expect global GDP growth to accelerate to 3.25% in 2017 from 3.0% in 2016. Growth in emerging markets, while still below-trend and choppy, we think has bottomed, and key emerging market countries such as Brazil and Russia could emerge from recession in 2017.

In the second half of 2016, we observed a cyclical pick-up in global growth as the economy in China stabilized and commodity prices recovered, accompanied by a dovish shift in U.S. monetary policy in February. Global Purchasing Managers’ Indexes (PMIs) have registered sustained increases and stand at levels that imply robust economic momentum, particularly in developed markets, and economic data has surprised to the upside. We see evidence that global manufacturing is recovering and that the inventory cycle is turning in support of growth, reflected in rising inventory investment and new orders-to-inventories ratios. In the U.S., the corporate profits recession appears to be over, and the strong labor market underpins domestic demand.

Against the backdrop of the underlying recovery in global growth, the outlook for 2017 hinges on questions around the policy mix. A shift to fiscal policy stimulus in advanced economies could boost global demand. In the U.S., our view is that the impact of fiscal policy will mostly be felt in 2018. We expect monetary policy in the euro area and Japan to remain accommodative.

China, inflation, populism top risks
Key macro risks for 2017 center on China’s economy, policy outcomes under the new U.S. administration, global financial conditions, and European politics.
  • We remain concerned about capital outflows in China, the devaluation of the currency, and financial stability risks. Chinese policymakers prioritized growth over reform last year; renewed attention on reform, implying less credit creation, could catch markets off-guard.
  • In the U.S., we think that the range of potential economic outcomes has widened under the incoming administration. A material fiscal easing, delivered in excess of market expectations, presents upside risk to U.S. growth and, by extension, global growth. However, with the U.S. economy already close to full employment, the introduction of fiscal stimulus could put upward pressure on inflation, prompting the Federal Reserve to tighten policy more quickly than priced in by the market.
  • A stronger than expected rebound in inflation could drive interest rates and potentially the U.S. dollar higher, leading to a tightening in global financial conditions, which would weigh on global growth and hurt emerging markets reliant on external borrowing.
  • The rise of populism and the pushback against international trade is a major economic risk, threatening to disrupt global supply chains and stoke inflation. For now, our base case is that President Trump does not ignite a global trade war despite protectionist rhetoric.
  • Finally, markets will focus on upcoming elections in the Netherlands, France, and Germany as tests of European integration in the wake of Brexit.
We view the risk of a recession in the U.S. as low currently, having declined materially from early 2016. Strong points for the economy include housing, construction outside of the oil sector, and state and local government purchases. The nonfinancial corporate sector continues to exhibit deteriorating credit quality, but the recovery in profits along with the potential for stimulus spending, tax cuts, and deregulation could give new breath to the economy and extend the cycle.

Based on our view that the Fed hikes twice in 2017, in June and December, which is similar to market expectations, we would be neutral Treasury duration. We are moderately bullish on the dollar assuming looser fiscal and tighter monetary policy, and see room for further appreciation. Equities should continue to do well in 2017. We prefer U.S. equities over many global markets given more clarity around the profits story in the U.S.
Gregory Hadjian, is a Macro Research Analyst at Loomis, Sayles & Company.

Greg Hadjian is a macro research analyst at Loomis, Sayles & Company. He performs global economic research and sovereign analysis for the macro strategies group. Mr. Hadjian joined Loomis Sayles in 2015, as a research associate, from the International Monetary Fund, where he was a research analyst. Previously, he was a financial services analyst at the Federal Reserve Board in Washington, DC.

Mr. Hadjian earned a BA from Cornell University and an MA from the Paul H. Nitze School of Advanced International Studies at Johns Hopkins University.