Managing expectations

Managing expectations

Advertising and social media mean we are never far from the self-helpish reminder to take time to pause and look at the view, but modern life often keeps us focused on the next goal. As investors, we always want to know what lies in store, but the change in the market and economic environment over the last few months means it is also instructive to look back and take stock.   

Since the start of 2017, equity indices across the globe have hit record highs, the US Federal Reserve’s interest rate raising expectations have moved notably higher, and the political obstacle courses on both sides of the Atlantic has provided a steady stream of headlines for investors to digest.

On the economic front, survey data around the world has surged, with purchasing managers’ indices (PMIs) for manufacturing in both the US and Europe hitting new highs. It is important to remember that these PMIs are month-on-month surveys that compare respondents’ attitudes and forecast output to the month before, so readings that stay above 50 indicate strong momentum.

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As a result of this momentum, investors have been alert to a slightly more hawkish tone in monetary policy. Against a backdrop of weaker consumer spending, but booming factory output, strong external demand and a notable pickup in business equipment, the Bank of Japan left policy unchanged. This briefly sent the 10-year Japanese government bond yield to its highest level in the past 12 months in the immediate aftermath of the announcement, before the BoJ stepped in with open market purchases, affirming its stance on targeted yield levels.

As expected, the Bank of England (BoE) kept interest rates on hold at 0.25 per cent and left its asset purchase programme unchanged. But notably, policymakers now expect the UK to grow by 2.0 per cent in 2017, up from last November’s forecast of 1.4 per cent, which was itself an upgrade from the 0.8 per cent forecast made in August 2016.

The BoE expects inflation to reach 2.7 per cent by the end of the year, well above its target rate of 2 per cent. However, it will tolerate overshooting of the target to some degree given the massive fall in sterling. BoE governor Mark Carney emphasised that he would watch real wage growth as a barometer for the health of UK consumers when thinking about possible changes to monetary policy through the end of 2017.

The Federal Reserve came out of its February meeting with broadly neutral messaging, but as positive US data continued to roll in, Fed officials began to turn more hawkish. Fed chair Janet Yellen’s testimony in front of US Congress provided a further strong signal that the Fed was ready to hike. As we go to press, I do not know the outcome of the meeting, but in the run up the market probability of a rate hike had risen to nearly 100 per cent.

Further evidence of the inflationary pressures building around the world came from China, where the producer price index rose even further to 6.9 per cent year-on-year in February. India’s GDP growth came in higher than expected at 7 per cent, particularly given prime minister Narendra Modi’s demonetisation drive. The cancellation of the majority of cash in circulation was expected to shave off some growth, but at least in this reading, India’s growth exceeded expectations, making it the world’s fastest-growing large economy.