Macro Focus: Positive Environment for Risk Assets?
The world economy is experiencing positive cyclical dynamics with reaccelerating momentum in developed and emerging markets. While growth rates remain modest, this broad-based financial expansion represents an important improvement compared to the poor macro picture in late 2015 (see Chart below).
Developed Markets: We anticipate above-trend GDP growth in the United States and Europe, with further improvement in the first half of 2017. While modest returns are likely given the extended duration of the business cycle, we anticipate a “mini-expansion” that favors equities and credit over government bonds.
Emerging Markets: We believe that the 2016 recovery will continue, particularly in Asian countries, but at a muted pace compared to historical standards. We see opportunity in equities and currencies of commodity-linked countries, as well as select emerging market currencies with cheaper valuations.
Improved U.S. Credit Conditions, but Long-Term Risks Building
After credit markets experienced a rollercoaster ride in 2016, our near-term outlook is more constructive given the broad-based rebound in global economic activity, the bottoming out in commodity prices, and U.S. dollar stabilization. Current spread levels may not offer room for meaningful price appreciation, but the asset class still offers an opportunity to harvest additional yields over government bonds.
Long-term risks in the U.S. corporate credit cycle include high and growing levels of leverage and proposed fiscal stimulus that could spur growth into a narrowing output gap, adding to rising inflationary pressures (see Chart below). Together, these factors could tilt risks toward higher rates, a stronger dollar and a renewed tightening in lending standards.
Fiscal and Monetary Policy Divergence Should Support U.S. Dollar
Proposals from the new U.S. President-elect’s administration suggest a substantial degree of fiscal stimulus over the next two years, and have important implications for the U.S. dollar. Should the U.S. engage in fiscal expansion coupled with monetary tightening, it will diverge from expected policy in the Eurozone, UK and Japan, potentially boosting the U.S. dollar against other Group of Ten (G10)1 currencies.
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11.The G10 is made up of 11 industrial countries (Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, Switzerland, the United Kingdom and the United States).