Stronger economic data trumps mounting political risks, for now
Euro zone firms eschewing political uncertainty and getting on with growing; China emerges from four years of producer price deflation; US manufacturing expanding at fastest clip in two years; Russia expected to emerge from a two-year-old recession this year
A tug-of-war is taking place in global financial markets.
On one side are the mounting political risks in advanced economies, particularly in the eurozone where strong support for populist parties have turned this month’s parliamentary election in the Netherlands and, more importantly, next month’s presidential election in France into focal points of investor nervousness.
On the other side are stronger economic data in both developed and developing economies which, together with the recovery in commodity prices, are improving the outlook for global growth.
While neither side is likely to triumph decisively, the brighter prospects for growth are helping mitigate the fallout from a sharp escalation in political risk which began with Britain’s shock decision last June to vote to leave the European Union (EU).
The stronger economic data also helps explain why global equity markets, as measured by the FTSE All-World Index, are hovering near a record high.
According to a report from Barclays published on Monday, “while attention has been focused on US and European politics, a synchronised turn up in growth and inflation globally, combined with a decline in real [interest] rates, has fuelled another leg up in risk assets”.
Over the past several months – and particularly since the start of this year – the economic recoveries of advanced economies have gathered significant momentum.
The most notable pick-up in growth has been in the euro zone.
On Wednesday, the publication of a purchasing managers’ index survey by IHS Markit, a data provider, showed that the bloc’s manufacturing sector expanded at its fastest pace last month since April 2011. According to IHS Markit, “manufacturers [in the euro zone] are eschewing political uncertainty and quietly getting on with growing their businesses”.
On Thursday, the publication of inflation data for Europe’s single currency area is likely to show that the headline rate in February increased to 1.9 per cent, just slightly below the 2 per cent target of the European Central Bank (ECB).
In the US, meanwhile, the once-ailing manufacturing sector is expanding at its fastest clip in more than two years while a report on Tuesday showed consumer confidence in February shot up to its highest level since July 2001.
Inflation is also rising sharply. On Wednesday, the US Commerce Department reported that the Federal Reserve’s preferred measure of inflation rose to 1.9 per cent in January, just a tad below the Fed’s 2 per cent target.
In emerging markets (EM), China’s economy, which has avoided a hard landing thanks to robust monetary and fiscal stimulus, recently emerged from four years of producer price deflation. With consumption holding up and exports cushioned by the weaker yuan, analysts are even raising their 2017 growth estimates despite persistent concerns about the rapid build-up in corporate debt.
China’s rebound, which has fuelled a recovery in commodity markets, is providing a fillip to growth in other leading EMs. Russia, a major oil producer, is expected to emerge from a two-year-old recession this year while the economy of Brazil, another major commodity exporter, is likely to stabilise after experiencing a steep downturn.
According to Barclays, “for the first time since early 2011, both [developed market] and [EM] data surprises are firmly in positive territory”.
Still, the stronger the economic data, the greater the scope for a faster pace of monetary tightening in the US and, more worryingly for stimulus-craving investors, a scaling back, or “tapering” of the ECB’s two-year-old quantitative easing (QE) programme.
On Wednesday, the odds of a Fed rate rise this month rose to more than 80 per cent – up from 36 per cent just last week – as William Dudley, an influential Fed governor, said the case for an increase “had become a lot more compelling.”
At the ECB’s closely watched policy meeting next week, Europe’s monetary guardian may begin to debate an exit strategy from QE.
The big question in the coming months is whether the less accommodating financial conditions start to make investors more sensitive to political risks in Europe and the US.
There are certainly plenty of reasons for markets to fret about politics, notably the turmoil in France’s presidential election campaign which is playing into the hands of Marine Le Pen, the leader of the far-right National Front party.
Yet, for the time being, traders are taking comfort in Tuesday’s decidedly more presidential address by US president Donald Trump to a joint session of Congress. The risk, however, is that having conspicuously failed to provide details about his economic plan, Trump is tempting fate at a sensitive time for investors.
The tug-of-war in markets is set to endure for some time yet.
Nicholas Spiro is a partner at Lauressa Advisory