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3 Drivers of Returns and Volatility in 2017

Hans-Jörg Naumer | 09/12/2016
Capital Market Monthly

Summary

Our Capital Markets and Thematic Research team says geopolitics, monetary policy and the global economy are the three factors that will exert the most influence on investments in 2017, but it could be a volatile mix.

Geopolitics: Following the election of Donald Trump as the 45th President of the United States of America, deglobalization will probably pick up speed – as will deficit spending to further inflate the national debt. In Europe, the UK is going to try and present a roadmap for Brexit by the end of March 2017. The Netherlands will elect a new parliament in mid-March, followed by presidential and parliamentary elections in France (April/May and June, respectively). After the summer break, elections to Germany’s lower chamber – the Bundestag – will take place by 22 October at the latest. Indeed, there are plenty of opportunities for (geo) political debate and associated volatility.

Monetary policy: This will probably remain one of the key constants. Irrespective of which course the much-debated US Federal Reserve adopts, it will remain expansionary overall, as will global monetary policy. Although the European Central Bank (ECB) is not expected to cease its policy of quantitative easing any time soon, it is slowly running out of arguments. The base effects of energy prices are already becoming noticeable and give rise to expectations of low consumer prices increasingly approaching the higher core rate. In addition, public-spending programmes are garnering wider support, while deglobalization and the associated higher tariffs will encourage price increases.

Economic growth: This trend should also be positive for domestic economies, at least in major world regions. The gaps in productivity are slowly closing, albeit at a stronger pace in the US than in the euro zone. Global purchasing managers’ indices support our expectations of another positive growth year ahead.

The guiding principle for investments in 2017 should be “reflation instead of deflation” in the context of inflation rates returning to normal. The reflation trend advocates portfolios that include riskier assets (eg, equities and bonds with risk premiums) again next year. Bearing in mind the geopolitical tendencies, however, we should be prepared for greater volatility.

As far as government bonds in the western hemisphere are concerned, the concept of reflation is increasingly moving towards centre stage. The European bond market will probably prove best able to withstand this trend. Thanks to the ECB’s interest-rate policy, yields – especially at the short end – are firmly in the grasp of monetary policy. Reflation should gradually become noticeable at the long end, although, here again, the ECB’s government bond purchases will probably hinder any stronger rises. Inflation-indexed bonds and shorter durations, generally, are becoming interesting.

These three most influential factors should make 2017 an exciting year for investing in the capital markets. Fortunately, volatility management can be delegated – for example, through the use of multi-asset investments.

For more information, read the December edition of Capital Markets Monthly or listen to the audio version on Soundcloud.

Investing involves risk. The value of an investment and the income from it will fluctuate and investors may not get back the principal invested. Past performance is not indicative of future performance. Investments in commodities may be affected by overall market movements, changes in interest rates, and other factors such as weather, disease, embargoes and international economic and political developments. Investments in smaller companies may be more volatile and less liquid than investments in larger companies. Investments in emerging markets may be more volatile than investments in more developed markets. Dividends are not guaranteed. Bonds are subject to interest rate risk and the credit risk of the issuer. This is a marketing communication. It is for informational purposes only. This document does not constitute investment advice or a recommendation to buy, sell or hold any security and shall not be deemed an offer to sell or a solicitation of an offer to buy any security. The views and opinions expressed herein, which are subject to change without notice, are those of the issuer or its affiliated companies at the time of publication. Certain data used are derived from various sources believed to be reliable, but the accuracy or completeness of the data is not guaranteed and no liability is assumed for any direct or consequential losses arising from their use. The duplication, publication, extraction or transmission of the contents, irrespective of the form, is not permitted. This material has not been reviewed by any regulatory authorities. In mainland China, it is used only as supporting material to the offshore investment products offered by commercial banks under the Qualified Domestic Institutional Investors scheme pursuant to applicable rules and regulations. This document is being distributed by the following Allianz Global Investors companies: Allianz Global Investors U.S. LLC, an investment adviser registered with the U.S. Securities and Exchange Commission; Allianz Global Investors GmbH, an investment company in Germany, authorized by the German Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin); Allianz Global Investors Asia Pacific Ltd., licensed by the Hong Kong Securities and Futures Commission; Allianz Global Investors Singapore Ltd., regulated by the Monetary Authority of Singapore [Company Registration No. 199907169Z]; Allianz Global Investors Japan Co., Ltd., registered in Japan as a Financial Instruments Business Operator [Registered No. The Director of Kanto Local Finance Bureau (Financial Instruments Business Operator), No. 424, Member of Japan Investment Advisers Association]; Allianz Global Investors Korea Ltd., licensed by the Korea Financial Services Commission; and Allianz Global Investors Taiwan Ltd., licensed by Financial Supervisory Commission in Taiwan.

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Hans-Jörg Naumer

Global Head of Capital Markets & Thematic Research
Hans-Jörg Naumer is Global Head of Capital Markets & Thematic Research with Allianz Global Investors which he joined in 2000. The focus of his work is on analysis relating to strategic and tactical allocations, specific investment opportunities and the identification of long-term investment trends. Before joining the firm, he worked for Société Générale, where he became the Head of Research Germany and was part of the French investment bank’s international research team. From his vantage point as an analyst and economist, he observed the establishment of the Economic and Monetary Union and thus ranked among the prime “ECB Watchers”. He started his professional career in the corporate banking division of Deutsche Bank in 1994. Hans-Jörg studied economics at the University of Mannheim, one of the leading universities for economics and business studies in Germany. During his studies, he worked at the Chair for Macroeconomics.

Rate Hike Seems Imminent, But Next Year Is Unclear

Franck Dixmier | 12/12/2016
Federal Reserve Bank Builiding

Summary

A 25-basis-point interest-rate increase by the Fed is fully priced in, and strong US economic data already bolster the case for more hikes in 2017. However, any projections for next year don’t reflect Trump’s as-yet unimplemented economic policies.

On 14 December, we expect the Federal Open Market Committee to announce a 25-basis-point increase in its fed funds rate. Markets already attribute a 100 per cent probability to this move and, as such, it is fully priced in.

In its subsequent communications, the US Federal Reserve will likely highlight the outlook for US inflation as an important factor to watch. While the central bank should acknowledge that the US dollar’s recent strength is tantamount to an implicit tightening of monetary conditions, this will be countered by upwardly trending salaries, oil prices and inflation expectations. This combination should validate the Fed’s scenario of rising core inflation and thus could justify additional rate hikes in 2017.

The question then arises as to how the Fed can respond to the prospect of rising inflation next year.

The FOMC’s new fed funds rates projections (the famous “dot plots”) will, despite their historically low reliability, be closely studied and could give a first indication of what the Fed will do next. However, we have to recognize that even with upward revisions, the last two years have shown just how little influence these projections have on markets, which have remained agnostic about the prospect of rising interest rates.

To this must be added the policy unknowns arising from the incoming administration of President-elect Donald Trump. In communicating its inflation and growth forecasts, the Fed cannot let itself incorporate what, to date, have been little more than pronouncements from Trump about his future economic policy. The central bank’s expectations in this area can only be reviewed appropriately once Trump’s actual programme has effectively been implemented.

In this context, it is likely that Fed Chair Janet Yellen’s announcement this week will only have a marginal impact on markets.

Investing involves risk. The value of an investment and the income from it will fluctuate and investors may not get back the principal invested. Past performance is not indicative of future performance. This is a marketing communication. It is for informational purposes only. This document does not constitute investment advice or a recommendation to buy, sell or hold any security and shall not be deemed an offer to sell or a solicitation of an offer to buy any security.

The views and opinions expressed herein, which are subject to change without notice, are those of the issuer or its affiliated companies at the time of publication. Certain data used are derived from various sources believed to be reliable, but the accuracy or completeness of the data is not guaranteed and no liability is assumed for any direct or consequential losses arising from their use. The duplication, publication, extraction or transmission of the contents, irrespective of the form, is not permitted.

This material has not been reviewed by any regulatory authorities. In mainland China, it is used only as supporting material to the offshore investment products offered by commercial banks under the Qualified Domestic Institutional Investors scheme pursuant to applicable rules and regulations.

This document is being distributed by the following Allianz Global Investors companies: Allianz Global Investors U.S. LLC, an investment adviser registered with the U.S. Securities and Exchange Commission; Allianz Global Investors GmbH, an investment company in Germany, authorized by the German Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin); Allianz Global Investors Asia Pacific Ltd., licensed by the Hong Kong Securities and Futures Commission; Allianz Global Investors Singapore Ltd., regulated by the Monetary Authority of Singapore [Company Registration No. 199907169Z]; Allianz Global Investors Japan Co., Ltd., registered in Japan as a Financial Instruments Business Operator [Registered No. The Director of Kanto Local Finance Bureau (Financial Instruments Business Operator), No. 424, Member of Japan Investment Advisers Association]; Allianz Global Investors Korea Ltd., licensed by the Korea Financial Services Commission; and Allianz Global Investors Taiwan Ltd., licensed by Financial Supervisory Commission in Taiwan.

© 2016 Allianz Global Investors. All rights reserved.

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Franck Dixmier

Global Head of Fixed Income, CIO Fixed Income Europe
Franck Dixmier is Global Head of Fixed Income and Chief Investment Officer Fixed Income Europe. Franck is a member of the Global Executive Committee as well as the European Executive Committee at Allianz Global Investors. Franck joined Allianz Group in 1995.
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