Will 2018 be another robust global growth with tighter monetary policy and growing inflation?
Global economy is in a stronger phase
We feel the combination of strong growth and low inflation will continue in 2018. Structural factors such as the effect of technology remains important, but cyclical forces suggest that inflation will begin to catch up with the strength of economic activity in 2018.
Global growth is more across the board and not just being the US centric growth. Advanced economies are now in a “sweet spot”, with the outlook on developing Asia and Emerging Markets positive. We project the global growth at 3.6% for 2018 from 3.4% in 2017, the fastest growth since 2011. For advanced economies, our 2018 US gross domestic product (GDP) outlook is 2.5% while the euro region GDP is 2.3% and Japan is 1.8%.
From our macro settings, it points to a reflationary environment driven by global trade boom that results in stronger growth and inflation as the upswing pushes commodity prices higher. Also, the US fiscal reflation sees a fiscal boost, incorporating deeper tax cuts and increased infrastructure spending, driving inflation higher, which is concentrated in the US.
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With a firmer inflation outlook in 2018 reinforced by stable oil and commodity prices, reflected with the pick-up in producer price inflation around the world, supports a further tightening of monetary policy. The US Federal Reserve (Fed), with its fiscal policy providing an extra boost to growth, should see three rate hikes in 2018 to 2.25% and one or two rate hikes in 2019 to 2.50%-2.75% from 1.5% in 2017.
Elsewhere, the European Central Bank (ECB) and Bank of Japan (BoJ) would move their respective monetary policies towards a tighter direction. The ECB should end its quantitative easing (QE) in September 2018 and institute rate hike in 2019. BoJ will continue the yield curve control and can expect the BoJ to raise the 10-year government bond yield target. It will be a turning point towards tighter policy.
Meanwhile, rate tightening is envisaged in many economies in Asian ex-Japan including Malaysia where we expect 1-2 rate hikes by 25 basis points from the current 3% overnight policy rate (OPR) in 2018.
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While the global economy is anticipated to continue its growth path in 2018 with the central banks to normalise their monetary policy, room for volatility driven by the short-term interest rate movements cannot be ruled out. Hence, while hoping for a relatively smooth year of positive returns in the financial markets, it is essential to take into consideration potential upsets that could arise from macro data failing to meet expectations, unexpected policy changes, political noises and geopolitical tensions.
Asymmetry or unanticipated shock could come from the central banks as they navigate towards a new global liquidity pattern. A runaway inflation scare will send interest rate expectation significantly high. Adverse surprises coming from below-expectations macro data could result to a sharp spike in the Volatility Index which is extremely low suggesting strong complacency among the investors.
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Deflationary environment is still on our cards, though the probability is low. It can happen if the current cyclical upswing eases and the global growth weakens due to the overshooting of the US Fed in its tightening monetary policy, euro runs out of ammunition, China debt crisis, deteriorating demographics and geopolitical risks. Sharp tightening of the financial conditions can add upwards pressure on bond yields, which can lead to a deflationary environment.
We should also take into account that markets have had a strong couple of years and valuations are tight. At the same time, risks abound. Geopolitical risks including North Korea, terrorism, Brexit and unpredictable political developments in Europe and the US make for an uncomfortable investing environment.
Improving global fundamentals to support Asian local bonds
While the global economy is anticipated to continue its growth path in 2018 with the central banks to normalise their monetary policy, room for volatility driven by the short-term interest rate movements cannot be ruled out. Hence, investors in fixed income will need to look beyond beta to meet their return requirements. It is becoming imperative to yield higher returns from fixed-income portfolios via asset allocation or security selection while managing the risks ahead.
Improving global fundamentals will continue to support investment flows into Asian local bonds. It should favour countries with strong fundamentals and room for growth potential. We like markets with positive fundamentals and reform momentum like India. Despite narrowing of liquidity surplus, going forward, pricing-in of incremental rate hikes by the US Fed and assuming there is no policy cut by the Reserve Bank of India, it can add upwards pressure on the 10-year government bond yields by 10-15 basis points in 2018.
A positive cyclical outlook for China is supportive despite the US trade protectionism being a risk. The central bank’s monetary policy will continue to be neutral with a tightening bias although fiscal policy will remain supportive with the launch of multiple large-scale infrastructure projects. While the risk of a debt-inspired collapse on the economy is there, chances of it happening is unlikely.
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We feel the rise in yields does provide opportunity to add long-term bonds. The Chinese bond market tends to deliver high nominal and real income, and benefit from stronger global growth and capital expenditure.
Also we expect the yuan to remain stable against the US dollar. The 10-year government bond yields should gain around 5-10 basis points in 2018.
Indonesia and Malaysia are expected to ride on the stronger global growth and commodity-sensitive and long-term valuations with some caution on the domestic noises.
For Malaysia, we expect the local bond yields to hold up to the pressure of US Fed rate hikes and also Bank Negara’s hawkish tone in the recent Monetary Policy Committee (MPC) meeting. We feel the current Malaysian Government Securities (MGS) levels have already partially priced-in a potential rate hike for the long-end of the yield curve. As for the short-end of the yield curve, we anticipate investors to eventually account the probabilities in.
Positive GDP growth outlook, improving business sentiment, supportive government policies and regulations and the firmer ringgit will continue to drive the demand for local bonds, moderating the potential rise in yields with some concern on the coming 14th General Election (GE14). We project the 10-year MGS yields to rise around 10 basis points in 2018.
Meanwhile, the demand for MGS that are long-dated will remain resilient, supported by players like pension funds and insurers. Gross issuance of MGS and Government Investment Issue in the 11 months of 2017 is at RM102.5bil while the corporate side gross issuance is RM111.2bil and corporate bond issuance is at RM118.5bil at end-November – all surpassing expectations of RM100bil-RM110bil and RM105bil-RM115bil for corporate bonds.
With several infrastructure projects expected to kick off in 2018 as announced in Budget 2018 where the funding requirements is up to RM1 trillion, we expect a large proportion of this to be funded via the bond markets over the next few years.
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In the US, with the expectations of gradual adjustment of the monetary policy, yield hunting will remain strong. Treasury Inflation-Protected Securities will remain attractive for the long run due to cheap valuations amid a more stable oil price and a still below target inflation.
In our view, a key factor that will influence the 2018 long-term yields will be the number of short-term interest rate hikes envisaged over a longer period. Much will also depend on the fiscal policy i.e. deficit-fuelled programmes that raise the Treasury supply, which is currently being envisaged to be broadly funded with short-maturity Treasuries rather than long-maturity bonds. We project the long-term rates to gain around 15-20 basis points in 2018.
As for the euro region, it is now more self-sustained with a broad-based growth driven by domestic and external demand. Politics will likely remain on the forefront, with Italian elections slated for no later than May 2018. Also, the Germans are risking another election.
Since we are not expecting any rate hike before 2019, the government bonds will continue to move sideways for most of 2018. We foresee long-term government bond yields to rise by 40-45 basis points in 2018. Alternatives to core government bonds such as corporate debt, high-yield, and European periphery bonds should remain well supported.
Opportunity exist in the equity markets
The synchronised global expansion in 2017 is poised to continue unimpeded in 2018 supported by broader based growth. It suggests to us that the economic cycle has more room to run which means that the trend of positive economic and earnings visibility, which supported the equity market returns in 2017, should continue in 2018, provided earnings growth maintains momentum.
In this environment of modestly rising interest rates and fuller valuations, opportunity exists for those stock markets to lead global equities in 2018. The economic risk is seen more favourable to equities supported by rising profitability that will boost returns over credit given tight spreads, low yields and a maturing cycle.
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Earnings in the US have recovered strongly and are now past their prior peaks. Still, earnings momentum is poised to stay strong in 2018 supported by the corporate tax cuts that could provide an extra leg up for earnings. Focus should be on momentum and value factors, financials, technology and dividend players. In the case of Europe, sustained above-trend economic expansion with steady earnings outlook will support cyclicals.
Corporate results will be remain the centre of attention. For Japan, the drivers are improving global growth, more shareholder-friendly corporate behaviour and solid earnings on the back of a stable yen outlook. While, the BoJ policy and domestic investor buying is seen as supportive, concern will be on a stronger yen.
Looking at Asia ex-Japan, drivers will be on storylines like economic reforms, improving corporate fundamentals, valuations and better-than-expected growth in the developed world. But the risk includes a sharp rise in the US dollar, trade tensions and elections.
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India, China and selected Asean markets like Malaysia will benefit in 2018. Concern is on a faster-than-expected Chinese slowdown that will pose risks to the entire region.
Malaysia’s equity market is expected to stay strong in 2018 supported by a strong flow of deals, healthy GDP outlook, firmer commodity prices and stronger ringgit against the US dollar.
Initial public offerings (IPOs) are poised to come from energy, infrastructure, financial services and consumer sectors. In 2018, one can expect several significant IPOs including Bank Islam, Edra Energy Global and potentially foreign insurers in Malaysia.
Besides, capital is expected to be raised through equity placements and right issues as the equity market continues to gain momentum. Furthermore, growth will come strongly from mid-corporate segment. Adverse noises from geopolitical risks and the upcoming general election will be temporary.
In the meantime, the debt market will remain positive, given the various funding requirements for infrastructure projects that are due to be rolled out. It will be financed through debt capital market, sukuk issuances, or project financing and loan syndication. Corporate bond issuance should be around RM90bil-RM100bil in 2018.
Anthony Dass is the Chief Economist at Ambank Group.
This article is published in collaboration with The Star. It is also published here.
Disclaimer: All opinions expressed in this article are the author’s own and do not necessarily reflect the views of the ASEAN Economic Forum.