The world is currently enjoying synchronised global growth for the first time since 2010, but according to Pimco’s global economic adviser, Joachim Fels, that growth could “peak” in 2018.
A ‘Goldilocks’ scenario of easy financial conditions, fiscal stimulus from developed countries and the continued suppression of financial volatility in China is currently “baked into” asset prices, Mr Fels said.
As such, investors should be watching three factors very closely to determine whether the current run-up in asset prices is likely to be coming to an end.
The first concern for Mr Fels is the high level of public debt in the developed world, specifically in the US.
The Republican tax bill, passed at the end of 2017, will add approximately US$1 trillion to US public debt over the next 10 years, the economic adviser said.
“Arguably, the last thing an economy operating at close to full employment in the ninth year of an economic expansion needs is a shot in the arm from fiscal policy,” Mr Fels said.
The expanded debt of the US government could become a serious problem when interest rates rise, Mr Fels said, and that it will deplete policymakers’ fiscal toolkit if they need it in the future.
“Higher fiscal deficits and debt levels imply that the room for fiscal stimulus in the next recession will be more limited,” Mr Fels said.
The second key risk going into 2018 is the risk that wage and/or price inflation will move higher as employment overshoots its natural level.
“The risks of a cyclical inflation overshoot in 2018 are rising given the globally synchronised nature of the expansion, additional fiscal stimulus, recent rises in commodity prices and super-easy financial conditions,” Mr Fels said.
“Global structural forces are still weighing down inflation, but the cyclical pressures are clearly on the up.”
Finally, there is the risk that global central bankers will make a policy misstep as they attempt to wind back a decade of accommodative monetary policy.
“The turn in the tide of global central bank policies poses significant risks to markets and economies, particularly as the new and still-evolving [US Federal Reserve] leadership is untested,” Mr Fels said.