Removal of monetary stimulus remains key to global outlook – Westpac

Global economic growth continues to improve, in particular the US where financial conditions are as easy as they have ever been and elevated household and business confidence readings add to the positive spin, explains he analysis team at Westpac.

Key Quotes

“Yet, inflation has remained low (stubbornly so) as wages fail to respond in many countries to this improved growth and employment outlook, and a series of idiosyncratic and temporary factors weigh. Although technological change suggests altered inflation dynamics could be more persistent and the Phillips curve not as reliable as in the past.”

“Thus, global central banks are being conservative and cautious in their withdrawal of monetary stimulus. Again, Fed is leading here, commencing balance sheet normalisation, and markets are now largely priced for a December 17 hike and further moves in 2018 (we forecast a further two hikes June and December 2018).”

“Markets have been absorbed by geopolitical concerns centred on North Korea and Iran, Fed Chair nomination, as well as question marks over Trump’s infrastructure and tax plans, yet this “goldilocks” backdrop of low inflation, solid growth and orderly monetary policy normalisation has been supportive for equity markets which have regularly been hitting new highs with low levels of volatility.”

“Volatility has also been suppressed in rates, FX and credit markets as investors continue to search for yield. We do think there is a risk we are about to embark on another hawkish swoon through 4Q17 as the focus globally returns to central bank tightening: BoC tightened in September; BoE rhetoric suggests “some withdrawal of monetary stimulus is likely to be appropriate over the coming months” and a November hike is forecast; Fed balance sheet normalisation and tightening to continue; and the ECB’s APP ends in December meaning their tapering plans will be announced in coming months. Any one of these events could be the catalyst for an increase in bond yields and volatility as we saw in June/July following Draghi’s Sintra speech.”

“For commodity markets, this growth backdrop is positive and metals and crude remain well supported. While not in the ‘super bull’ camp, we do expect to see fresh 2017 highs for crude in coming months.”

“For China, the focus is the National Congress and the leadership and agenda for the coming term. The economic backdrop appears supportive, with the PMI reports and credit data pointing to momentum being sustained in the second half of 2017.”

“In Europe growth has strengthened and is expected to persist. However, with considerable labour market slack, it continues to rely on ECB support with populism resurfacing and Brexit weighing. Low core inflation, a lack of wage pressures and likely lengthy tapering are keeping yields low, as the path to “normalisation” will be very, very long.”

“For the UK, core inflation remains relatively high and households are under pressure. Politics and Brexit travails are also impacting sentiment and look likely to undermine confidence in coming months. BoE is likely to remove at least some of their post-Brexit-vote accommodation, but it could well be a “one-and-done” rate move into 2018.”