• Marco Annunziata

Buckle up

One should never say “I told you so”. Never. It is irritating and inelegant.

But…what the heck…my optimism for 2017 has been vindicated. We have entered 2018 with stronger economic growth and record high stock markets. In the U.S., it now appears reports of the death of wage growth and inflation were greatly exaggerated.

I remain optimistic for 2018 — this time going with the consensus flow… — but with more caution. Here are four things worth considering in the year ahead.

1. Turn off the news and look for the details. We have all found religion. We have found it everywhere, and it blinds us. Politics is paralyzed by partisanship: your opponent is not simply wrong, he is evil. On climate change, you are either a believer or a denier. Reasonable debate has become rare; finding reliable balanced information harder than ever. Do your own research, because a lot is changing in health care, energy, regulations, etc. The headlines — outraged or triumphant — don’t bring you one step closer to understanding the impact.

2. Sentiment matters. A year ago I sensed people were tired of perma-pessimism. I hoped that improvements in the business environment would sustain confidence and feed it into investment. This seems to be happening. Small business optimism, which enjoyed an unprecedented surge after the 2016 Presidential elections, remains at record high levels. A majority of economists expect tax reform will boost investment and growth.

3. Don’t get too excited. If you have been following the economic news you get the impression that after many years of stagnation and near-recession, the economy is taking off to a much brighter future. That is an exaggeration. Yes, last year was better than 2016, and this year is looking healthy. But take a longer view: the next five years look about the same as the last eight. To paraphrase Billy Joel…”the bad ole days weren’t all so bad, and tomorrow ain’t as good as it seems…” I don’t mean to be a kill-joy. I am optimistic and I see some upside above the consensus forecasts. But to bring advanced economies back to the ~3% pre-crisis growth rates it’s going to take more hard work on the business environment, and more investment. We’ve made some progress in the U.S., Japan and parts of Europe. We need more.

4. Buckle up. Because central banks and financial markets have unfinished business. Now that they finally admit the economy can stand on its own legs, central banks can (and must) start unwinding the awe-inspiring multi-trillion-dollar balance sheet expansion of the last ten years (about $15 Trillion by the major central banks combined). They will do it gradually and carefully. The financial sector no longer suffers from the reckless leverage of 2006. But reversing ten years of massive quantitative easing and zero/negative interest rates is an unprecedented experiment. It would be folly to assume they can pull it off smoothly, without shocks or accidents. Yes, central banks have successfully cushioned the recession. But in the monetary expansion phase they could wield the sledgehammer, shocking financial markets with massive liquidity injections. The tightening phase needs to be finely calibrated, carefully managing market expectations. That’s a lot harder. Bond yields are starting to edge up. Central banks hope the adjustment will be gradual. But the last few years have cemented a consensus that inflation is dead and the natural interest rate permanently lower — so the risks are all skewed on one side. This will be a much bumpier ride than you were told.

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