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  • Hermes: Overly protective
    Neil Williams
    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.
  • Economic outlook: Questioning Goldilocks...
    Neil Williams
    •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. But, 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. Moreover, central banks’ ‘skin in the game’ suggest they cannot take us off guard, which should, more than in other growth recoveries, limit the rise in bond yields.
  • November 30, 2017
    Macroeconomics & Risk
    Economic outlook: Looking into 2018...
    Neil Williams
    •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.
  • September 1, 2017
    Macroeconomics & Risk
    Not tight, just less loose...
    Neil Williams
    Ten years after the first glimpse of crisis, & major economies have recouped their GDP. But, despite ‘muscle flexing’, the road to policy normalisation will be long & slow, with the prospect of another two years of negative real rates in the US, UK, Japan, & euro-zone. Our analysis suggests that by sustaining its QT programme, the US Fed could ‘take out’ as much as 130bp of further rate hikes by 2019. US rates, when they peak, should be far lower than we’re used to.
  • US Fed - addressing the balance sheet...
    Neil Williams
    •The US Fed is the first central bank to suggest it’s worrying about our addiction to QE. It’s about to become the test case for how to push both levers: gradual rate hikes & balance-sheet correction. •To quantify the impact on rates & gauge how policy should shift, we update our ‘Policy Looseness Analysis’. By including QE, QT, & fiscal considerations, our analysis beefs up the Fed’s Taylor Rule which recommends an unrealistically high & damaging peak rate. •By sustaining its proposed ‘non re-investment’ (QT) programme, the Fed could ‘take out’ as much as 130bp of further rate hikes by 2019. But, unless it’s accelerated, it would take till 2023 before the balance sheet is taken back to the $1trn considered ‘normal’. •Interest-rate normalisation will also be slow. Even a possible $1.1trn QT by 2019 leaves the de facto, QT-adjusted, real funds rate negative - on both our dovish & the FOMC’s hawkish rate views. •This gives credence to the ‘new normal’ view of low-for-longer global rates/yields, rather than a ‘normalisation’ in coming years to pre-crisis levels. Otherwise, the US’s eight-year expansion (its third longest) may not in summer 2019 become its longest ever...
  • Brexit - speed bumps, slopes, & cake
    Neil Williams
    •After 12 months in the departure lounge, our Brexit negotiations have started. Political fall-out has added an extra ‘speed bump’ on a journey likely to take way longer than the two years hoped for. •Mr Hammond’s more conciliatory tone is welcomed, but is inevitably clouded early on by ‘cherry picking’. Our negotiations could take years to potentially end up back close to square one, in terms of striking the free trade agreement that most parties want. •When the deal is struck it will need Parliamentary approval, & be subject to a ‘phasing in’ period. And this after sign-off by our 27 EU peers. Striking a US deal by the 2022 UK election needs talks to start now - well before Mr Trump’s 2018 ‘Mid-Terms’ campaign. •Which leaves the BoE watchful that a weaker pound doesn’t keep pumping inflation. The MPC could feasibly reverse its 25bp ‘safety net’ rate cut from last August. But, in the absence of a recovery in real wages, we doubt they would hike any more aggressively. •Tapering their QE reinvestments would be the gentlest way to tighten. If it helps, Mr Carney may then be able to have his ‘cake’ (unhindered consumption) & ‘eat it’ (still low policy rates)...
  • The wrong sort of inflation...
    Neil Williams
    •By debating the size of their balance sheets, central banks are showing the first signs since the crisis that they may be worrying about our growing addiction to QE. After unclogging the system in 2009, QE has since been an imperfect remedy. •But, its impact may not have been properly picked up. By taking explicit account of QE & fiscal positions, our analysis suggests the true US policy rate may be as low as -4%, & -3% in the UK. •This may be just as well, as, without care, an unhelpful jigsaw piece from the 1930s - retaliatory trade protectionism - might yet come crashing into place. The impact of protectionism this time, though, could be far more complicated. •First, the economic & financial linkages suggest the knock-on would be more far reaching. Global retaliation would activate second-round effects that later offset the initial growth-impulse from Mr Trump’s intended tax cuts.
  • Budget Commentary: Fiscal tweaks – a warm-up to triggering Article 50
    Neil Williams
    Neil Williams, Group Chief Economist at Hermes Investment Management, sets out his reaction to today’s Spring Budget: Having set out his stall in November and still awaiting the main event – our Brexit negotiations - the chancellor’s fiscal tweaks today were never going to raise too many eyebrows. Sterling’s fall since the Brexit vote has so far cushioned the economic blow, allowing him a sunnier growth outlook for this year, and more optimistic tax-take.
  • Economic outlook: Beggar thy neighbour...
    Neil Williams
    •Markets are taking more than a ‘glass half full’ view of the macro outlook, with little consideration of the new risk emerging. In the short term, this makes sense, as speculation, rightly, that major economies will open the fiscal box is sparking ‘reflation trades’. •Yet, while better for growth, 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. •In which case, markets face a year of two halves, where stimulus-euphoria gradually gives way to stagflation concern. Helpfully, the trade-off, though, is that policy rates stay lower than many expect. •The impact of protectionism this time could be far more complicated than in the 1930s. First, the economic & financial linkages suggest the knock-on would be more far reaching. Global retaliation would activate second-round effects that later offset the initial growth-impulse from Mr Trump’s tax cuts.
  • February 6, 2017
    Equities
    Brexit – has the fog lifted?
    Neil Williams
    After Theresa May’s explanation of the Brexit process and The Supreme Court ruling, the UK’s intended departure date and destination look clearer. But, in his latest Ahead of the Curve monthly, Neil Williams, Group Chief Economist at Hermes Investment Management, believes the largest uncertainty now is the length of the journey ahead. Our negotiations, he argues, could stretch well beyond the two years assumed by Article 50.
  • February 1, 2017
    Macroeconomics & Risk
    Ahead of the curve: Brexit - has the fog lifted?...
    Neil Williams
    Explanation of the Brexit process & The Supreme Court ruling have made the UK’s departure date & destination clearer. But, the largest uncertainty now is probably the length of the journey ahead. Our negotiations could stretch well beyond the two years assumed by Article 50. Maintaining access to, rather than full membership of, the customs union looks nearest to Canada’s model. But, this took seven years, & ours may have to be even more ambitious.
  • January 5, 2017
    Macroeconomics & Risk
    Euro-zone – time for Plan B...
    Neil Williams
    The ECB’s decision prior to Christmas to extend QE for another nine months to December 2017, though ‘taper’ it from this April, does not herald an early tightening of economic policy, according to Group Chief Economist Neil Williams in his January Ahead of the Curve. Quite the opposite in fact, with the key deposit rate likely to stay negative in 2017, and the fiscal side activated. 2017’s extra QE easily surpasses the combined GDPs of Greece & Portugal... Tapering means more QE. By tapering its monthly asset purchases from €80bn to €60bn, it’s still looking to inject an extra €540bn in QE. This easily surpasses the combined GDPs of Greece and Portugal. Central banks can now buy bonds that yield lower than the -0.4% deposit rate. However, the nuance, is Mr Draghi’s growing encouragement of governments to take the baton back from the ECB. A lesson from Japan is that QE provides cash to lend, but cannot force consumers and firms to borrow. The euro-zone thus looks halfway down the Japan route. It too may be running unconventionally loose monetary policy (QE and negative rates) to get its currency down, but has yet to let go of the fiscal reins.