Stock markets were buoyed by a potent combination of global economic growth and low inflation last year – known as the Goldilocks economy. This not too hot, not too cold, environment has meant stocks and bonds across the globe rose in value last year, almost without exception.
But as we begin a new year, the question is; how long will it last? The two threats to the Goldilocks economy are that either of the dual factors – growth or inflation – disappoints. This is because if either one of these metrics shock central bank policy makers, it would force them to make a decision about interest rates. This in turn would create volatility in stock markets, as institutional and individual investors alike flee less attractive assets for those that offer a better return.
“It is unlikely to be economic growth that disappoints this year,” says Michael Metcalfe, head of Global Macro Strategy at State Street Global Markets. “Most indicators suggest growth will continue. If anything, we think economic growth could be stronger this year – it could accelerate from this level.”
Metcalfe says that the growth story is so strong because it is not led by just one country – there is promising economic growth in the US, Europe, Japan and emerging markets – lending stability.
“In 2017 there were many events that would have resulted in stock market turbulence in any other year,” he said. “But markets are uncorrelated, each has the resilience of their own growth drivers.”
Inflation is Key Risk
And so that leaves inflation. Economists are divided about the inflation outlook. Markus Schomer, chief economist for asset managers PineBridge Investments, says that inflation will be benign this year, with the exception of the UK, where the post-Brexit vote fall in sterling is still taking its toll.
But Metcalfe is not so optimistic. He believes that inflation is on the rise in the US, and will forced the hand of the Federal Reserve’s Open Market Committee to raise interest rates.
“We’ve had many years since a recession. We are reaching capacity in the labour market, so inflation is a risk. Of course, we said this last year, but core inflation in the US fell. But if you take a better look at the data you can see that was down to just a couple of elements. Mobile phones dropping in price made up nearly 50% of the downward pressure on inflation over the summer,” he explained.
It was this drop in inflation over the summer that caused the Fed to pause its rate hiking cycle, but Metcalfe expects this to be a one-off event – inflation is on the rise.
“If you strip out energy prices, inflation in the US is already above 2%. March’s data will be a key figure to watch. Growth is robust. If Goldilocks is to break, it will be inflation that does it,” he predicts.
