After one year, the Federal Reserve has hiked rates again, signalling that next year it may do so again three on three occasions instead of two. This time, the markets seem to believe the Fed, helped by expectations for aggressive federal tax cuts next year….
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Intesa Sanpaolo – Research Department For professional investors and advisers only
Measures of economic policy uncertainty stand at much higher levels than the historic average. For the time being, the expectations of reflationary policies from the new US administration are prevailing over risks associated with the electoral cycle in Europe. However, not necessarily higher uncertainty will translate in smaller investments and slower growth. The limited impact, so far, of the UK vote on the economy, against expectations of very gloomy scenarios, is emblematic.
In 2016, Economic Policy Uncertainty indices rose significantly in all the advanced countries, and marked two new all-time highs: the first on the win of No vote at the referendum on UK membership in the European Union, and the second on the US presidential elections. Concerns over the effects of the UK referendum have mostly been reabsorbed – to the point that even the United Kingdom index is currently at levels not far off the long-term average, despite uncertainty clouding the duration and outcome of the negotiations. The high triggered by Donald Trump’s election to the White House has also been overcome in part – although in December the US indices were still well above their long-term averages almost everywhere. The trend of the Italian index is not much different, and has been apparently unaffected by the outcome of the constitutional referendum and by the short government crisis which ensued. Besides, according to Economic Policy Uncertainty, the levels of anxiety inferred from the media (linked to terrorism, war, insecurity etc.) are at their highest in France, the United Kingdom, and the United States, whereas in Germany, while still very high, they are below the highs hit between the end of 2015 and early 2016.
In general, we should expect higher uncertainty over economic policies to reap negative effects on GDP growth, mostly tied to the depressive effects on businesses’ investment decisions. However, even acknowledging such an effect, other factors have partly counterbalanced it: the depreciation of the sterling, looser fiscal policy in the United Kingdom, and expectations for tax cuts not financed by spending cuts in the United States. In general, in the past few months, economic data have kept surprising on the upside, and monthly surveys data are compatible with an acceleration of global GDP between 2H 2016 and the beginning of 2017. In the United Kingdom, the average of GDP growth forecasts for 2017 has risen from 0.9% to 1.4% in three months; the investment trend forecast has improved from -1.8% to -0.3%, and an increasing number of analysts even expect investments to turn positive by around one per cent this year. The truth is that questioning the status quo does not always imply a negative fallout on growth, and that each case should be analysed individually.
Then, there is also the issue of the trade-off between near-term and long-term effects. The markets appreciate stability and continuity, which make investment decisions easier. However, if electors display mounting adversity to the policies which characterise the status quo, resorting to artifices to guarantee its immediate perpetuation may prove unsustainable in the long term. As observed by Cas Mudde in an article published by Foreign Affairs a few months ago, the combination of the convergence of moderate right and left-wing parties on very similar positions on the one hand, and the increasing recourse of governments to so-called TINA (There Is No Alternative) politics, offers fertile ground for the success of populist movements. In Europe, the proliferation of broad coalition governments (a sort of antipopulist “cordon sanitaire”, also a form of TINA politics), risks making the future victory of some populist formation more likely and more overwhelming, unless it is accompanied by a significant agenda change in the direction requested by voters.
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