Over the past 18 months we’ve seen three major shocks, each of which were expected to have a significant impact on growth:
1. The late 2015 Chinese yuan devaluation/capital outflow shock
3. The Trump election
Many people expected the Chinese economy to slow sharply in 2016. It didn’t.
Many people expected the UK economy to slow sharply after mid-2016. It didn’t.
Many people expected growth and inflation to rise significantly after Trump was elected.
The third prediction still might come true, but this FT article suggests that investors are moving away from the “reflation” trade.
We are nearing the anniversary of a great market turning point. Like most such turning points, it was not obvious as such at the time, but in early July last year markets reached the lowest point of their fear of deflation — falling prices amid a stagnating economy — and started to position for reflation.
The shock of last summer’s Brexit referendum brought bond yields, the market’s most direct expression of its belief in deflation, to a historic low. The rebound started as the effects of China’s economic stimulus were felt, while it grew clear that Brexit had not sparked a financial crisis.
It gathered momentum after Donald Trump’s victory in the US presidential election. The theory was that the Trump administration would pick up the baton from China, which looks over-leveraged and will soon need to ease off its stimulus, and would bring in its own growth-friendly policies, including tax cuts and infrastructure spending. From “reflation off”, we moved emphatically to “reflation on”.
Stock markets have risen this year, but 2017 has seen a gradual shift back to “deflation-off”. Short-term inflation expectations have moved sharply in recent weeks. The bond market’s implicit forecast for US inflation over the next two years, once at 2.15 per cent, has dropped to 1.35 per cent.
In each case I expected some effect, but less than the consensus. In the case of China and Brexit, even the very mild slowdowns I predicted proved too bearish. I’ve learned my lesson from Brexit, and in the future will pay no attention to “uncertainty shocks”. Always a skeptic, I am now convinced that uncertainty has virtually no significant business cycle effects. And never bet against Chinese growth. Someday it will falter, but no one can predict when.
[In macro, the forecast most likely to be true is, “Not much will change”. However the way to build a reputation is to forecast dramatic changes. You will usually be wrong, but the public will forget those mistakes and give you undeserved praise on the few occasions when you are correct.]
I’m sticking with my prediction that Trump’s policies might lead to a couple tenths of a percent faster NGDP growth. Monetary offset will keep inflation close to 2%, and Trump’s supply-side reforms are likely to be modest (at best). An extra couple of tenths of one percent NGDP growth is so small it will be almost impossible to tell if I am correct—especially given that growth is likely to slow as we approach full employment. If there is a recession, however, or 5%-6% NGDP growth persisting for a few years, then I will clearly be wrong.
Maybe the French will give us another shock later today.
PS. I still believe that Brexit itself will reduce UK growth. This post discusses the effect of pre-Brexit uncertainty, not Brexit itself, which is still years away.
PPS. I believe the US should withdraw from the IMF. Not because the IMF is not good enough for the US, rather because America is not good enough for the IMF. If we don’t leave, I hope the other IMF members expel us:
Finance ministers and central bankers from around the world have dropped a pledge to resist protectionism, in a further sign that the new US administration’s stance on trade is shifting the global debate.
The group from International Monetary Fund member countries issued a statement on Saturday saying they would “promote a level playing field in international trade” but did not reiterate a previous commitment to “resist all forms of protectionism”.
The change of stance mirrors a similar move made by the finance ministers and central bank governors of the G20 countries after they met in Baden-Baden in March. On that occasion, the US was unwilling to endorse forthright language on protectionism.