2016 was the year marking the end of the fear of even lower interest rates, and a new hope of a progressive rise of rates, even if not to the past prevailing pre-crisis levels. Secular stagnation (the prolonged period of low interest rates and low growth) is an over-rated concept and I believe that growth and inflation are back in 2017.
Fiscal policy has to take over to lift demand
The current demand slack is not the destiny of the global economy. Policy-makers can address the lack of demand by adopting an appropriate mix of monetary and fiscal policies - and they have the means to do so. Far from the caricature of „conservative central bankers“, central bank policymakers across the world have deployed incredible creativity to address stumbling demand. Monetary policy will never be the same as before the Global Financial Crisis. Moreover the extended tool box is here to last. In some countries, this is not enough: fiscal policy has to take over to lift demand and help restore cyclical momentum and this is particularly the case in the euro area, where some, but not all countries, have the fiscal space to do so. Overall, we see some potential for cyclical policies to support growth in the U.S., in the north of Europe and we expect China to continue on this path, despite rising imbalances.
Less global savings chasing investments
In the medium term, the saving glut, partly responsible for the decline in rates, is set to resorb. In the developed markets, ageing projections, assuming little changes in inequality, suggest a slowly declining saving rate as countries pass the ageing peak. Across emerging ones, the changing growth model, from export-driven towards more domestic investment and consumption, together with improved financial institutions, will slow the pace of accumulated savings. Notably, the build-up in foreign exchange reserves which followed the balance of payment crises of the 1990s appears to be coming to a standstill. Elsewhere, Middle-East oil savers also have to face the challenging environment of lower oil prices. Overall, we expect that this will mean less global savings chasing investments.
Technology is already showing in the data
Finally, productivity will regain some strength. We dispute the idea of a low productivity growth based on the absence of technical progress. Technology is already showing in the data. The countries investing most heavily in the digital economy will benefit extensively, as they will be the most well-equipped to seize opportunities to reform their production capabilities. The technology drive could spread out even faster, especially if structural reforms of labour and product markets provide a tailwind. New technology and digital developments would in turn increase production levels and therefore potentially boost trend growth potential.
As economies recover, these three elements should push the global economy toward higher growth rates than observed since the financial crisis. Even with conservative assumptions on a productivity level and without complacency on the impact of Brexit, our estimates put the U.S. trend growth at 1.6%, while the UK (affected by Brexit) and the euro area would reach an average of 1.25%, Japan would remain around 0.6% over the coming decade.
Taking into account these growth estimates and modelling the term premium, we estimate that U.S. long-term rates should return to 3.4% in the coming five years. This is certainly far from current levels, implying a multi-year normalisation that should radically affect asset allocations. We are not only leaving a world of declining rates and inflation but we are also turning to a world where rates will converge towards higher levels and inflation closer to central bank targets. Even though it is unlikely that we will see a return to the exuberant levels last seen in the 1990s and 2000s. See you in 2017, with the return of yields.