January Investment Strategy: Beware of economic euphoria
Key Points:
Eurozone growth keeps surprising to the upside and forecasters are typically too slow to react. We revise our expectations to 2.5% this year, above consensus.
The European Central Bank has signalled its readiness to tighten policy. We now see more upside to the EUR/USD and target 1.28 by year-end.
Economic optimism has not made risks disappear though. Comments from politicians, as exemplified at the recent Davos conference, could prove disruptive for markets and eventually lift volatility.
Normalisation of monetary policy in sight
As the World Economic Forum in Davos comes to a close, it appears that the global economy is riding a wave of euphoria. Right now economic data hasn’t been this encouraging since before the financial crisis. It seems it’s time for policy normalisation, or at least, monetary policy normalisation. It’s time for interest rates to edge up and financial stability concerns to rise, as is usual in this phase of the cycle, when talks switch from anxiety about the strength of the recovery, to concerns that monetary policy has perhaps been overly accommodative for too long. But in our view, economic conditions are as supportive as possible, from the micro perspective (cheaply and abundantly financed, technology and digital innovation is, lifting productivity at last), to the macro, where the policy mix remains benign. All of these elements have combined to provide a conducive backdrop for political errands such as FX talks or trade disruption. And this is why we believe volatility may soon be back...