Voter discontent and unpredictable geopolitical headwinds could deliver fresh electoral surprises in the year ahead and help spur a new economic policy approach, says Newton Investment Management fixed income investment leader Paul Brain.
After a year of political shocks, including the UK’s vote to leave the European Union (EU) and U.S. election victory for Donald Trump, Brain anticipates a period of steady growth this year. However, he believes this will be followed by an economic slowdown in 2018 and warns of the potential for more political upsets ahead.
Brain adds that rising wealth inequality and a growth in populism could ultimately force policymakers to shift their approach away from fiscal austerity and persistently low interest rates in order to boost economic growth.
“While the U.S. economy is growing, buoyed by previous monetary stimulus, and economic recovery is underway in Europe, inflation is rising quite sharply and central banks need to consider their monetary policy carefully. Investors should also monitor the changing economic outlook and guard against potential market upsets,” he says.
From a political standpoint, Brain sees potential risk ahead in the forthcoming UK and French parliamentary elections, with the outcome of the next Italian election also of major significance to the Eurozone.
“As we saw with the Brexit vote last year, there is a lot of dissatisfaction with the current state of play. It is possible this feeling of discontent will linger throughout the upcoming elections in the UK and France— leading to a demand for a change in government policies that could lead to a slippage in fiscal prudence.”
“In Italy, anti-establishment sentiment is also rising. Italian public support for the EU and euro is currently among the lowest in Europe, which is a concern,” he adds.
Commenting on the U.S. economic landscape, Brain predicts further interest-rates rises from the U.S. Federal Reserve will cause bond yields to spike upwards and inflation to return later this year. He adds that much depends on President Trump’s ability to deliver on policy promises. After an abortive attempt to reform U.S. health care, he adds, Trump now looks unlikely to force through major tax changes in the short term.
Against this backdrop, Newton’s global bond team is applying a flexible investment approach within its strategy. Outlining the tools, which drive the strategy, Brain said he currently favors U.S. Treasury Inflation-Protected Securities (TIPS) and bank bonds and the team has built exposure to assets within the U.S. construction/reconstruction sector. Brain remains bullish on some emerging markets, despite ongoing credit problems in countries such as Brazil and South Africa and the potential for further fi instability in China.
The global bond team does, however, remain cautious on the high yield bond sector.
Regarding this topic, Brain adds: “If you consider how much high yield investors get paid in terms of actual yield, and also the likelihood of rising default rates over the next two years, then they are not particularly well rewarded. With the added potential for volatility in the sector, we fear this is an asset class that could be an accident waiting to happen.”