It was another strong year in 2017 for investments, with low double-digit returns across most markets generated hand-in-hand with rising global corporate profitability (up 15% in 2017), and solid economic growth.
The question everyone wants to know the answer to now is whether the bull market can continue throughout 2018.
It’s often been said that bull markets don’t die of old age, but rather they’re killed by the Federal Reserve (Fed). This one appears to be no different. As written about previously, geopolitical risk tends to be no more than a short-term nuisance for markets (offering good trading opportunities), but unless the event is very serious (e.g. sovereign default of a large economy, or a calamitous war), there is little chance of it having meaningful impact on the global economy five or ten years down the line.
For this reason, central bank policy (which directly impacts the price and quantity of money) is the key area to watch.
After raising the benchmark lending rate in December 2017 to a target range of 1.25% to 1.5%, the Fed forecasts a further three 0.25% rate rise across 2018. However – having been let down over the past several years – the interest rate futures market is not pricing this in, factoring just a 20% probability of three hikes by year-end. Traders in London also expect a very benign UK interest rate environment, pricing in a slim 40% chance of an interest rate move from 0.5% to 0.75% by the end of 2018.
With the markets seemingly calling the central banks’ bluff, inflation data is going to be closely watched over the year ahead. If inflation rises faster than expected, central banks may be forced to raise interest rates to choke off growth, but if it remains under control then this extended period of low rates and loose monetary policy could continue for longer than expected.
That said, it’s true that headline inflation has started to move, particularly in the UK where sterling depreciation and rising commodity prices – from a low base – have filtered into the data. However this is still seen as a transitory effect; core inflation is still not especially elevated, which we can see in Chart 1.
In actual fact, core inflation has been dropping in the US, and the Eurozone continues to struggle to generate much inflation at all. As long as this state of affairs continues, interest rates should not surprise on the upside.
Chart 1: Core Inflation