Expect Quantitative Tightening in 2018

Mercer recently outlined key themes and trends expected to influence economic and market dynamics in two papers: 2018 Global Outlook and the 2018 Global Themes and Opportunities. The investment themes that institutional investors should be considering, according to Mercer, include: the impact of a move from quantitative easing (QE) to quantitative tightening (QT); preparing for late cycle dynamics; and political fragmentation. The global economy is growing at the fastest pace since the financial crisis of 2008, Deb Clarke, global head of research at Mercer, said in a release. We expect this to continue into 2018, though this is likely to be reined in by tighter monetary policy at some point in the next few years. Overall, we view the primary risk to economies and markets as the ability of central banks to unwind easy monetary policy at an appropriate pace; particularly the risk that the Fed raises interest rates too aggressively. Here's the top line summary of Mercer's themes: From QE to QT In response to low levels of unemployment and robust growth, Mercer noted that many of the world's major banks are starting to pull back on expansionary monetary policies. The U.S. Federal Reserve recently announced a plan to gradually normalize its balance sheet over the coming years. The Bank of England implemented its first rate hike since 2007 in November 2017. The European Central Bank has announced a reduction in the rate of asset purchases from January 2018. The pace and scale of the shift from monetary easing to tightening will be a major influence over economies and markets through 2018 and beyond. Preparing for Late Credit Cycle Dynamics The later stages of a credit cycle typically present a challenging environment for investors, offering lower returns and greater risks than the early or mid-cycle periods. While it's anticipated the current economic strength will continue into 2018, investors should start considering the ways in which they might prepare portfolios for the risks and opportunities that the late stage of this credit cycle could present. In relation to the risks associated with the late stage of the credit cycle, Mercer suggests that investors be wary of chasing yield in certain segments of the credit market and make sure they are being adequately compensated for taking illiquidity and complexity risk. More generally, we believe that investors should be prepared for an environment with higher levels of volatility than seen in 2017 and to understand the impact that large market moves, and a tightening of liquidity conditions could have on their underlying portfolios, Clarke wrote in an email to us. On the flipside, the late stage of the cycle may also present opportunities for investors who are able to be nimble and dynamic. For example, Mercer said, a faster-than-expected withdrawal of monetary stimulus could create opportunities in distressed debt as companies that have become reliant on cheap financing may struggle to adapt to a rising yield environment. Political Fragmentation Since the financial crisis of 2008, politics have become increasingly polarized, manifesting in the Brexit vote, elections across Europe, the election of Donald Trump and more recently in the Catalan bid for independence. Investors are likely to face an environment of heightened political uncertainty for some time and should consider stress testing portfolios when reviewing their strategy in 2018. Mercer said stress testing will need to be investor-specific to reflect the nature of their underlying strategy and an appreciation of the outcomes to which they are likely to be most sensitive. However, in broad terms, we believe investors need to have a clear understanding of the impact that large movements in equity, bond and currency markets could have on their financial position, Clarke wrote. There is no single stress scenario that investors can prepare for -- instead, investors need to ensure that portfolios are robust under a wide range of potential outcomes. This article was originally sent to subscribers of TheStreet's Income Seeker, a product presenting the world of opportunities in fixed income and dividend stocks. Click here to learn more about Income Seeker and to receive articles like this from Robert Powell, Peter Tchir and others.

Expect Quantitative Tightening in 2018

A look at Mercer's global and economic outlook for 2018.

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