Economist Insights

ab
4 January 2016
Asset management
Market resolutions for 2016
Economist Insights
Based on the experiences of 2015, we once again suggest some
New Year's resolutions for the market. Among others:
• I must behave like an adult if I want central banks to treat me
like an adult
Joshua McCallum
Head of Fixed Income Economics
UBS Asset Management
[email protected]
• I must acknowledge that lower potential growth means
earlier rate hikes
• I will start the year with more humble expectations of growth
• I will treat emerging markets as emerging (yet again)
• I will think of Greece as a holiday destination, rather than as
destroyer of the Euro
• I will recognise that the global economy is diverging
As we close our fourth year of Economist Insights it is time
once again to look at the New Year's resolutions that we
believe the market should follow. What lessons should the
market take from 2015 to avoid repeating the same mistakes
in 2016? Our suggestions follow, along with links to the
Economist Insights issues that provide more detail.
I must behave like an adult if I want central banks to
treat me like an adult.
Central banks need to think about risks, so it makes sense to
talk about risks. But when the market scrutinises every word
of every sentence, mentioning a new risk is likely to trigger an
over-reaction from the market. So when the Fed mentioned risks
from China back in September, the market suddenly decided
that China was the pivotal factor in the Fed's decision. The Fed
themselves likely thought it would have been odd not to have
mentioned events in China, but only as a risk. Seeing the childish
market reaction to that one line, they removed it in the next
statement even though the risks persisted. The market is clearly
not mature enough to handle a grown-up discussion of risks.
See Splendid Isolation, 2 November 2015.
I must remember that rates can rise.
This may seem obvious to people in many countries, but in the
major investment markets (US, Eurozone, Japan and UK) it has
been more than eight years since we last saw a rate hike (if we
ignore the ECB's policy error in 2011). Despite some doubts on
the way, the Federal Reserve finally hiked rates in December.
Central banks do not tend to hike once and forget it, so there
Gianluca Moretti
Fixed Income Economist
UBS Asset Management
[email protected]
should be more to come. The question is simply how fast and
who else will follow. See Half-Fed, 21 December 2015 and
International Monetary Fears, 7 September 2015.
I must acknowledge that lower potential growth means
earlier rate hikes.
The market consensus is that potential growth is lower in most
economies than previously thought. Since this is bad news,
most people assume that this means monetary policy must be
looser. But if rate hikes are predicated on narrowing the gap
between actual growth and potential growth, the gap will then
be smaller. Just look at how little growth is apparently needed
to bring down the unemployment rate. So lower potential
growth may mean an earlier start to rate hikes, although the
terminal rate would then be lower. Unless, of course, interest
rates are currently too high, as suggested by the idea of secular
stagnation. See Theory of relativity, 1 June 2015, Potentially
misleading, 13 April 2015 and Going spare, 16 November 2015.
I must change how I think about the effects of oil
on economies.
After oil prices fell sharply in the latter part of 2014, pretty
much everyone (ourselves included) thought that this would
bring a big boost to the oil importers. In the event, the modest
growth was a bit of a disappointment (unless the counterfactual
was that growth would have been awful). The behaviour of
OPEC has also been unusual, and has led to lower oil prices for
longer than many expected. See Side Effects, 28 September 2015
and Show and Cartel, 14 December 2015.
I will start the year with more humble expectations
of growth.
Each year the market has been over-optimistic on growth
for the global economy. Early optimism in January gives way
through the year to more and more pessimism (most of that
in the first few months). There was one notable exception
this year, which was the Eurozone, where the market started
out pessimistic but was pleasantly surprised. Perhaps if the
market finally starts out more pessimistic on global growth,
Murphy's law will kick in and we will get upside surprises.
See Delphic, 5 January 2015 and Functional forecasts,
12 January 2015.
I will treat emerging markets as emerging (yet again).
This is one of those resolutions that is a lot like giving up
smoking, after failure it is repeated each year. Emerging
markets are, by their nature, volatile which means they are
risky. China was the prime example this year, as investors
were reminded that when markets are imperfect (thanks to
state control) prices can get out of kilter very quickly.
See The 'Greater Fools' of China, 13 July 2015, Catching cold,
27 July 2015 and Easy come, easy go, 5 October 2015.
I will recognise that the global economy is diverging.
After many years of integration and globalisation, it really
does look like economic outlooks and monetary policy are
diverging. This is not just an emerging versus developed
market split, there is a split within each of those groups
as well. This also means greater currency divergence, even
amongst those with a long history of being pegged to the
USD. See Globalessation, 12 October 2015 and Fixation,
17 August 2015.
I will not overestimate the impact of the rest of the
world on the US economy.
The stronger USD was widely predicted to cause big problems
for US growth, but in the event the US has been fairly solid.
And in any case, what matters for the global economy is US
domestic demand (which includes imports), not US GDP.
See Import-ant, 16 March 2015, Easing off, 26 October 2015
and Fixation, 17 August 2015.
I will think of Greece as a holiday destination, rather
than as destroyer of the Euro.
Once again a change in the political situation triggered a
panic about Greece, and once again the economic (and
political) realities won the day. The situation did become
rather surreal when Syriza rejected a deal in order to hold a
referendum which also rejected the deal, only to accept what
was essentially the same deal the following week. But this
just demonstrates that in the face of sharp economic realities
the political grandstanding is just that. See Will it all end in
Drachma?, 22 June 2015, Burning Bridges, 6 July 2015 and
Icarus, 14 July 2015.
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