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Neil Williams argues that comparisons between G7 economies’ current experiences and those of Japan since the late 1990s are more than just a coincidence...

Political risk is ‘trumping’ economics, with a confluence of factors such as populism...

In this latest economic outlook, Senior Economic Adviser to Hermes Investment Management, Neil Williams talks about finding neutral.

In his Q4 Economic outlook, Neil Williams, Senior Economic Adviser to Hermes Investment Management, argues that even a decade after the fall of Lehman Brothers - central banks will be slow to lift a tide of liquidity still hiding the rocks beneath.

Neil Williams, Senior Economic Adviser, Hermes Investment Management: “After softer activity data, the BoE's rate-hike today, their second in this cycle, may raise some eyebrows. However, it shouldn't be seen as heralding a swift move upwards. “As with their first rise last November, the Bank's tone again reflects caution. Suspecting that its room to manoeuvre will become more constrained as Prime Minister May seeks a Brexit Treaty in 2019, it may be putting as much store on tactics as long-term strategy. Even if there is a deal next year, it would most likely only be a precursor to sorting out the various legal and trade systems by December 2020. “Motivating today's move will be the MPC’s assessment of very little slack left in the economy, and building excess demand. It will also be hoping that spring’s pay settlements data have been strong enough to help validate the traditional link with low unemployment. “Yet, their window to hike may become smaller in 2019, and even close by 2020. UK growth has almost ground to a halt - from the top of the G5 quarter-on-quarter growth-table in H2 2016 (just after the referendum) to the bottom by H2 2017 - despite a softer fiscal stance.”

To test whether the macro strains in the eurozone periphery are still holding back the core members, Neil Williams, Senior Economic Adviser to Hermes Investment Management, updates his ‘Misery Indices’ (MIs) out to 2019. He finds that, with macro-economic convergence between euro members next year set to be the strongest since 2007, they should be on a better footing to weather their next challenge - linked perhaps to Italy’s political risk. Off-the-wall methods for proxying economic hardship include an index adding together a country’s unemployment and inflation rates. Though hardly scientific, they become especially flawed in a low inflation or deflationary world when the components may move in opposite directions. We offer a more logical alternative to this, and to GDP estimates, which are produced with more of a time lag and frequently revised.

In his latest Quarterly Economic Outlook, Neil Williams, Senior Economic Adviser to Hermes Investment Management, argues that markets are still taking a ‘glass half full’ view of the macro outlook, with little real consideration of the new risk emerging. Until now, this has made sense, with speculation the US would open the fiscal box having justified ‘reflation trades’. However, while better for growth (see chart 1), markets are ignoring the darker cloud looming. Rather than financial distrust, we may need to brace for political distrust with the threat of beggar-thy neighbour policies - from the US to anti-European populism - rising. 2018 could be a ‘year of two halves’... In which case, 2018 could be a year of two halves, where stimulus- euphoria gradually gives way to stagflation concern. Helpfully, the trade-off is that policy rates stay lower than many expect. As chart 2 attests, the world’s appetite for international trade has, as a share of GDP, more than doubled in the past 50 years. Nevertheless, without care, the unhelpful jigsaw piece of retaliatory protectionism from the 1930s, might come crashing into place. In 1930, it was triggered by the Smoot-Hawley reforms that raised US tariffs to up to 20% on over 20,000 imported goods. This hit the US’s relatively small number of trading partners, most notably Canada and Europe, and prolonged the depression.

In his latest Quarterly Economic Outlook, Neil Williams, Senior Economic Adviser to Hermes Investment Management, argues that the recent market moves are a useful reality check, but believes that markets may be fearing the wrong 'bear'. The recent weakness of equity markets looks driven more by the drift-up in bond yields, US tightening expectations, and what they may mean for future growth, rather than any downturn in the economic data. A testament to recovering, rather than relapsing, economies. The challenge now for markets questioning the ‘Goldilocks’ scenario of ever faster growth and ultra-low rates is to identify which of the ‘bear’ risks to fear. Declines from peaks to troughs in equity markets are traditionally associated with macro shocks, and/or a toxic policy-mix. However, with policy rates still close to the floor, QE close at hand, and little effort on fiscal-deficit cuts, policy can hardly be accused of being toxic. Two feasible triggers could be an extension of the bond-yield rise since the US Fed started its ‘belt and braces’ tightening, and a slower China, but, these should be contained. Furthermore, central banks’ skin in the game suggests they cannot afford to take us off guard. This, more than in other growth recoveries, should limit the rise in bond yields.

In his latest quarterly Economic Outlook, Neil Williams, Group Chief Economist at Hermes Investment Management, sets out his five core macro beliefs for 2018. He argues that, in the Lunar Year of the Dog, the ‘bark’ of global central bankers may end up being far worse than their ‘bite’. If central banks want their powder back, the Fed’s dual mandate may make sense While 2017 was (like 2016) dominated by geopolitical risk (North Korea, alleged US/Russia links, European populism), none of that was allowed to seep into financial markets. Lubricated by cheap money, a $15trn sink of QE, and the prospect of US tax cuts, reflation trades have raised the ‘cost’ to investors of missing out, even if they lack conviction. The frustration for central banks is that recoveries since 2009 have been mainly output driven. Unemployment is a reducing drag. Yet, with output gaps slow to close and wage pressure capped, these recoveries are failing to generate enough inflation to trigger central banks’ usual reaction functions.

•While 2017 was again dominated by geopolitical risk, none of that was allowed to seep into financial markets. Reflation trades prevail. Yet, the frustration for central banks is that recoveries are failing to generate enough inflation to trigger their usual reaction functions. •If they truly want to get their ‘powder’ back, in terms of reclaiming policy rates while core inflation stays tame, the spirit, if not the letter, of the Fed’s dual mandate may make sense for others too. •While this may be deemed ‘hawkish’, it would be more than offset if we need to brace for more political distrust: with the threat of beggar-thy-neighbour policies - from the US to an upsurge of anti-European populism - a major risk still unpriced by markets. •Amid these forces, our macro outlook is based on five core beliefs. First, despite ‘muscle flexing’, the road to normalisation will be long & slow. Real rates will stay negative, with ‘peak’ rates ending up below what we’re used to. The question is how to drain the liquidity ‘sink’ without unintended consequences.

Neil Williams, Group Chief Economist at Hermes Investment Management, sets out his reaction to today’s autumn Budget: With splits in the Party, Brexit looming, and disappointing UK productivity growth, two things from today’s Budget were inevitable: that it was going to be more political than economic; and that lower growth assumptions would involve higher borrowing ratios further out. With Brexit yet to be financed, Mr Hammond was today never going to show other EU governments watching unbridled fiscal largesse. Through lower growth assumptions (a cumulative 2.2 percentage points), he has effectively had to loosen the fiscal reins again relative to plan, and, depending on how Brexit plays out, may have to kick further down the road the goal he set out last spring to return the deficit to surplus “...sometime in the next Parliament” scheduled for 2022/23. His predecessor, Mr Osborne, had wanted that surplus for three years earlier.

As the BoE raised rates for the first time in a decade the pound plunged and we saw the worst day for sterling since the post-Brexit plummet. Will sterling continue to struggle? And are there more rate hikes on the horizon? Neil Williams, Group Chief Economist at Hermes Investment Management, gives his take on the Bank of England Inflation Report and says the hike was a one-off muscle flex from the BoE giving them more powder to use in an economic slowdown.