Get ready for lift off

Global economic prospects are looking healthy, with the recent dip in data expected to be temporary.

March 2015

Key points

  • The outlook for the global economy remains encouraging, aided by ongoing monetary easing and weaker energy prices.
  • Impending rise in US rates has dampened our enthusiasm for equities and other risk assets.
  • The dollar will rally further, supported by widening US interest-rate differentials against those in other leading economies.

An optimistic outlook

The outlook for the global economy remains fairly bright. The US and UK look to be in healthier shape than they were three months ago. And while concerns persist over the situation in the Eurozone and Japan, easier monetary conditions should increase confidence. 18 central banks worldwide have already eased monetary conditions this year as policymakers look to take advantage of tumbling inflation – aided by plunging oil prices – to bolster economic growth.

Reducing appetite for risk assets

At the same time, an impending first hike in US rates since 2006 has dampened our enthusiasm for equities and corporate bonds. Instead, we are focusing on regional selection. We are overweight European and Japanese equities, where prices should be supported by loose monetary policy. And we are underweight ‘emerging’ stocks - a rising dollar has a historically negative impact on these markets. As for government bonds, ‘developed’ markets appear overvalued but we do not expect a dramatic rise in yields at this stage. Global property markets still look attractive compared to other income generating assets.

Expecting the US dollar to strengthen

The US economy remains the strongest among the G7 and the most advanced in its recovery phase. We have long expected the US Federal Reserve (Fed) would  ‘look through’ low inflation readings to the extent they were driven by weaker oil prices. Further, the dollar still does not look especially expensive. For example, on a trade-weighted basis it is still some 4% below its 50-year average in real terms. No surprise then that the Fed continues to signal that it is likely to begin hiking rates around June.

In the medium term, we expect the dollar to become the highest yielding currency among leading developed nations. In that case, it should continue to benefit from so-called ‘carry trades’ where investors borrow cash in one currency to invest in higher yielding assets’ often in another currency.

In the medium term, we expect the dollar to become the highest yielding currency among leading developed nations

Stewart Robertson

Senior Economist (UK and Europe)

Quantitative easing set to keep a lid on volatility

Since the start of the fourth quarter of 2014, the volatility of asset prices has soared as the Fed halted ‘quantitative easing’ (QE). Although the Fed has wound up monthly asset purchases of $85bn (£54.7bn), the European Central Bank (ECB) is now committed to buying €60bn (£43.9bn) of assets a month from March until September 2016 or beyond. And last October the Bank of Japan (BoJ) increased its QE programme to ¥80 trillion of assets a year (£36.5bn a month).

Assuming the Fed reinvests the proceeds from maturing securities bought under QE, the combined balance sheets of the Fed, ECB and BoJ will continue rising at a similar trajectory to recent years. This should help to cap market volatility in the near term, particularly as the ECB is prepared to increase its programme if necessary.

Summary

A number of factors have the potential to increase volatility. Deflationary forces, particularly when mixed with high levels of leverage. Increasing levels of risk-taking. And a more turbulent and uncertain global political backdrop. Yet even if spikes in volatility occur this year, we expect their magnitude will continue to be dampened by the actions of central banks. This may create opportunities for ‘relative value’ trades with spikes in volatility likely to be higher in emerging markets than, say, the US.

 

 

Important information:

Except where stated as otherwise, the source of all information is Aviva Investors Global Services Limited (“Aviva Investors”) as at 2 March 2015. Unless stated otherwise any opinions expressed are those of Aviva Investors. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested. 

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