With monetary policy at its limits for major developed economies like the U.S. and Europe, there will now be a shift to fiscal spending and in the U.S., a normalization of monetary policy. The U.S. electorate voted in a highly controversial POTUS in large part based on his promise of higher infrastructure investment and tax cuts. Reflation will replace deflation or “Japanification” as the word du jour. Populism has, and will likely continue to, drive political changes during elections, reversing decades of globalization and reducing the high level of policy (especially monetary) coordination among developed countries that we had seen post-2008. For now, fears of “secular stagnation” give way to hopes for a cyclical recovery, particularly in business capital spending. In the most recent few months, public companies are being rewarded by investors for actual or planned capital spending and investment, rather than being rewarded for returning capital by way of dividends and buybacks. Negative-yielding bonds have finally been recognized by investors as an irrational investment, leading to a sharp sell-off in bonds during the last quarter of 2016. REFLATION WILL BE CAPPED … BUT STEEPER YIELD CURVES HERE TO STAY A sharp rally in commodity prices from multi-year lows have increased real-time inflation measures, producer price indexes (PPI) and future inflation expectations as reflected in steeper bond yield curves globally. A deeper look under the hood of data such as recent China PPI data shows the majority of the upward pressure has come from higher commodity prices. Until we see sustained wage growth in the global economy, we believe that the broader deflationary impetus of an aging population in the largest economies will cap inflation. However, after years of flattening yield curves, we do anticipate a normalization to a steeper curve. After eight years of quantitative easing (i.e. money printing) and interest rate cuts ultimately ending in more than US$10 trillion of developed country government bonds with negative yields in mid-2016 but with limited impact on stimulating economic activity, the baton is passed to stimulatory fiscal policy. Despite the optimism, we are cautious because the implementation of infrastructure programs often takes longer than anticipated. However, we welcome the shift away from unorthodox monetary policies that clearly had reached its limits in effectiveness, other than impacting asset prices.
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