December 29, 2016    9 minute read

The Year Of Exotic Economic Policies: Global Overview For 2016

A Troubled Year    December 29, 2016    9 minute read

The Year Of Exotic Economic Policies: Global Overview For 2016

The continued uncertainty and political shocks have taken their toll on the global economy this year. In 2016, the public debate was driven by key interest rate hikes, quantitative easing, unconventional monetary policies and the effect of politics and foreign affairs on global economies. After each surprise vote result, markets and currencies were the first to react, but the effects seemed to lessen as the year progressed.

The markets started to learn and priced in the unexpected, in order to rebound quickly. As referendums and elections made headlines in the West, Asia was testing extreme economic measures – from Shinzo Abe’s three arrows to Narendra Modi’s surprise demonetisation. All in all, probably the most interesting and eventful year since the 2007/2008 global crisis.

Currencies

United_States_Dollar_Index_Price_TMMChart (2)

The dollar rose on the back of the poll indication Clinton would be voted President of the United States. However, it fell momentarily when it was announced that Trump had, in fact, won the election. Since the US labour market has steadied and the economy has proven to be extremely resilient this year, the Fed hiked interest rates, and the dollar rose significantly in proportion to the other major currencies.

British_Pound_Price__TMMChart (1)

The British pound tumbled to a 31-year low this year after the referendum on Britain’s membership on the EU and Theresa May’s promise to deliver what appeared to be a Hard Brexit weakened confidence in the once stable currency. The pound this year has been likened to an Emerging Market currency.

Since 2006, the renminbi has floated in a narrow margin around a fixed base rate determined by a basket of global currencies. The appreciation actions by the Chinese government and quantitative easing measures by the Fed and other major central banks saw the yuan rise during the latter half of the year. The Chinese government will increase the flexibility of the currency in the upcoming year in the hope that the renminbi will become the world’s reserve currency. Earlier this year the renminbi was included into the IMFs basket of currencies.

Euro__Price_TMMChart

The Euro fell against the dollar after the Brexit announcement on June 23rd due to concerns about the future stability of the eurozone. It also fell following Renzi’s loss in the Italian referendum as investors were concerned about the future of Monte dei Paschi and whether the Italian banking crisis would spark another euro-wide financial meltdown.

The Japanese yen fell against the dollar in the middle of the year as Prime Minister Shinzo Abe continued to struggle to boost growth. His policies include a bold monetary stimulus, fiscal spending and structural reforms and they have struggled to defeat deflation.

Central Banks – Key Interest Rates

Screen Shot 2016-12-23 at 13.25.03

Markets

Dow_Jones_Industrial_Average__[Close]_TMMChart

The Dow neared 20,000 in December at a level that has not been seen before. Donald Trump’s victory over Hillary Clinton saw all major US stock markets whipped into a frenzy. Both the S&P 500 Index and the Nasdaq composite index rose by 6% and 5.6% respectively during the same period. The outlook for equities in 2017 seems extremely bullish.

FTSE_100___[Close]_TMMChart

The FTSE 100 saw a new 10-week best on December 23rd at 7,068 and closed at a record of 7,106 on December 28th. Market activity has been spurred from Brexit and the election of Donald Trump encouraging more investors into equity trading this year.

Euro_Stoxx_50__[Close]_TMMChart

Euro Stoxx 50 closed at its highest level since January despite a marginal tumble after the announcement that Monte dei Paschi would need to be bailed out by the Italian government. The Euro Stoxx rose in December after gains were made on the Italian referendum.

Key Events In the Global Economy

OPEC Deal

On November 30th, member states of the OPEC countries agreed to cut production to 32.5m thereby removing 1.2m barrels a day from the global oil supply, commencing in January 2017. With non-OPEC nations, including Russia and Kazakhstan, consenting to the deal on December 10th, global production will be cut by almost 2%, significantly more than markets had anticipated.

The West Texas Intermediate crude prices rose to their highest level since 2014, to $52.98 in mid-December. In the past, oil producing countries have formed agreements but have been unable to stand by them due to their reluctance to significantly reduce their volume of sales and market share.

Oil prices had fallen last year after Saudi Arabia had sought to mass produce barrels of oil to flood the market with the supply and force the closure of many American fracking companies which had been newly built on their recent discoveries. The IEA announced that inventories would not drop to the point where demand exceeds supply until midway through 2017 if the deal is met by all parties. US oil companies are currently using the price rally to hedge their price risk for the next couple of years and are looking potentially to boost output next year.

Federal Reserve Rate Hike

The Federal Reserve chose to raise interest rates for the second time this decade on December 14th. The rates were raised by 25 basis points from 0.5% to 0.75% thereby increasing the cost of borrowing for 2017. Federal Chair Janet Yellen supported the decision by indicating that the labour market was tightening and inflation expectations had increased “considerably”.

Central bankers are reportedly expecting a three-quarter point rate increase in 2017 as the US inflation rate is well on the way to its 2% target. In a detailed speech that followed, Yellen stated that the health of the US economy had raised the living standards for most American households. Wage growth is increasing, as are weekly earnings for young workers.

4.6% is the US unemployment rate

US unemployment is 4.6%, the lowest it has been in nine years. Yellen cited the increase in wage growth and the weekly earnings for young workers as the principal reasons for the boost in the health of the US economy.

Yellen told graduates at the University of Baltimore that “after years of a slow economy recovery, you are entering the strongest job market in nearly a decade”.

Bank Of England Monetary Policies

In December the Bank of England announced that it would keep interest rates at 0.25%, but Governor Mark Carney did warn of the risks of rising inflation which could result in monetary policy moving in either direction in 2017.

The Bank of England aims to keep inflation rate at a steady 2%. The Monetary Policy Committee at the Bank of England predicted that inflation would rise from its current level of 1.2% to above the target in 2017. Since this forecast, the pound has appreciated by 6% on a trade-weighted basis. On news of the announcement, the currency fell on the back of the dollar from $1.2694 before the Fed raised US interest rates to $1.2446.

Carney cited the “fragile” economic environment with the rising debt levels in China and the unfolding crisis of the Italian banking sector for his caution. Consumer spending in the UK has been growing confidently, despite apparent price increases of several imports due to a weaker pound. The Office For National Statistics released data that retail sales had grown 0.2% in November.

Demonetisation Of India

In November, India’s Prime Minister Narendra Modi took a remarkable decision to void 86% of the cash in circulation. The aim was to clean out the money supply in the black market. 500 and 1,000 rupee notes were immediately declared void while Indian citizens were given a 50-day window where they could exchange their old currency for the newly released 500 and 2,000 rupee notes or deposit them into their bank accounts. There have been some immediate disastrous consequences: businesses have been unable to pay their workers or suppliers and the new notes cannot be printed at a pace that is fast enough for the demand.

There are many sectors of the economy which are struggling to cope with the sudden lack of cash. India has demonetised its economy before: once in 1946 and again in 1978. Modi intended the policy to be a surprise, in the hope that the black market could not be prepared for a sudden cut in cash supply, but not even the Indian banks were told of the innovative monetary policy scheme. Far from reaching a recovery by the end of the year, it is thought that the Indian economy will take at least four months into 2017 to adequately restore the monetary supply.

Bank of Japan Policies

In September, analysts at the Bank of Japan felt that the Japanese economy had run out of options for stimulus. However, after the victory of Donald Trump, the mood changed to optimism. The yen plunged from ¥104 against the dollar to ¥118. Interest rates at the Bank of Japan are currently at -0.1% and the cap of 10-year bonds yields at zero. Negative interest rates have been implemented to reduce the cost of borrowing in an attempt to stimulate the economy. Prime Minister Shinzo Abe also introduced his so-called three arrows (“Abenomics”) of fiscal stimulus, structural reforms and monetary easing.

-0.1% is the BOJ key interest rate

The Bank of Japan is continuing to purchase government bonds at a pace of ¥80trn a year, corporate bonds at a pace of ¥3.2trn and equities at a pace of ¥6trn.

It is likely that the Bank of Japan will maintain this current, highly expansionary policy until there are clear signs of rising wages and consumer prices fulfilling a self-reinforcing cycle.

Key People Of The Year

  • Mario Draghi: the Governor of the European Central Bank
  • Janet Yellen: the Head of the Federal Reserve
  • Mark Carney: the Head of the Bank of England
  • Shinzo Abe: Prime Minister of Japan
  • Haruhiko Kuroda: Governor of the Bank of Japan
  • Narendra Modi: Prime Minister of India
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