Central bankers
leave key
questions
unaddressed

by Kristina Hooper,
Chief Investment Strategist,
Invesco Ltd.

August 30, 2017

Last week brought arguably the most important event in the monetary policy calendar, as central bankers and economists from around the world converged on Jackson Hole, Wyoming, for the Kansas City Fed’s annual economic policy symposium. Two of the most powerful central bankers – U.S. Federal Reserve Chair Janet Yellen and European Central Bank (ECB) President Mario Draghi – both gave momentous speeches, but neither one gave attention to the key topics on investors’ minds with regard to their economies.

In the case of the U.S., Chair Yellen didn’t discuss balance sheet normalization or persistently low inflation. And in the case of the EU, President Draghi did not discuss tapering of the ECB’s quantitative easing program – nor did he talk down the euro. Instead, both used the Jackson Hole platform to argue against some of the most powerful trends spreading around the world: deglobalization and deregulation.

Yellen’s speech: Defending regulation

In Ms. Yellen’s speech, she defended regulatory reform. She argued strenuously that the increased regulation that has occurred in the wake of the global financial crisis (GFC) helped prevent another crisis. She recognized that the regulation wasn’t perfect, however, and that some aspects of the Volcker rule – intended to stop the type of speculative banking activity that contributed to the GFC – could be changed in order to improve liquidity. She also admitted that there is room for deregulation of smaller banks, recognizing that there is unnecessary complexity in their regulation. However, she cautioned against any broad rollback of regulation: “Any adjustments to the regulatory framework should be modest and preserve the increase in resilience at large dealers and banks associated with the reforms put in place in recent years.”

Draghi’s speech: Promoting productivity

In his comments at Jackson Hole, Mr. Draghi noted that the global economic recovery is accelerating, but that Europe and Japan are in the early stages of their recovery – suggesting they need continued monetary policy accommodation. I would argue that his speech was far more important than Ms. Yellen’s in that he tackled the difficult topics of demographics and productivity.

Mr. Draghi warned that the cyclical recovery that many countries are now enjoying could deteriorate without stronger potential growth. And stronger potential growth requires either higher population growth or greater productivity. Since demographics are not working in developed countries’ favour, Mr. Draghi made it clear that “the burden of raising potential growth must fall on productivity.” He believes this can be encouraged in a variety of ways from a policy standpoint – supporting competition, research and development, and especially free trade.

In short, Mr. Draghi made an impassioned – and timely – plea against protectionism, just as both the North American Free Trade Agreement and Brexit negotiations are underway. Understandably, free trade and globalization are currently under attack in a variety of areas around the world as industries and employment opportunities have changed over time. In particular, some countries are lamenting the loss of jobs in certain industries such as manufacturing. That Mr. Draghi focused his comments on free trade suggests to me how concerned he is about the deglobalization movement and its potential negative impact – and with good reason, given that protectionism exacerbated the Great Depression of the 1930s. The question is whether nations will take heed.

Fitch expresses concern over U.S. debt ceiling

In other news, debt ratings agency Fitch Ratings gave a rating warning for the U.S. as concerns grew that the country will not be able to raise its debt ceiling in a timely fashion. Fitch expressed its concern that if the debt limit is not raised with adequate time before the U.S. runs out of available money, it would review the country’s debt rating, suggesting “potentially negative implications.” Fitch added that prioritizing debt payments is unlikely to be enough to protect its rating: “We have previously said that prioritizing debt service payments over other obligations if the limit is not raised – if legally and technically feasible – may not be compatible with ‘AAA’ status.”

Recall that in the summer of 2011, Standard & Poor’s not only gave the same warning, but in fact lowered the U.S.’ rating from AAA to AA after Congress’ deadline came and went – but also after it had approved the lifting of the debt ceiling. Fitch’s warning is a red flag; it is clearly worried that Congress will not lift the ceiling in time. And it’s a reminder that a similar scenario – a stock market sell-off – could result if Congress is unable to lift the debt ceiling in a timely fashion. We will want to follow this situation closely as Congress prepares to return from its summer break.

U.K. reports sluggish economic growth

Finally, we learned last week that the United Kingdom’s economy grew at a tepid 0.3% pace in the second quarter – half that of the eurozone. Weakness came from business investment and household spending. This suggests that economic policy uncertainty is stifling both business and consumer spending – which is not surprising, given that historically there has been a negative correlation between economic policy uncertainty and business investment.

And the recent release of the U.K.’s Brexit position papers does not seem to have allayed any concerns over uncertainty. The customs paper could be described as “aspirational.” In particular, the U.K.’s expectation of maintaining the same trade relationship with the EU through a transition period seems unrealistic, especially as the U.K. would like to utilize the transition period to negotiate trade deals with other countries. Because Article 50 was invoked in March, the U.K. has only two years to negotiate this complicated exit as well as its future relationship with the EU – and therefore runs the risk of falling off a cliff with no post-Brexit arrangement in place.

Key takeaways for investors

As you may recall, one of the key themes I have underscored this year is disruption – and geopolitical risk can of course lead to disruption. And disruption can create volatility and place pressure on asset prices. I believe investors should consider an adequate allocation to alternative investment strategies that have the ability to take short positions, which can profit from a fall in an asset’s value. These strategies can potentially deliver positive returns in falling markets, which means they could help offset losses incurred by other assets in an investor’s portfolio. In particular, a market neutral strategy may help with this objective. In addition, several types of alternatives – such as those that invest in currencies, commodities and real estate – have historically had low correlation to traditional stocks and bonds, giving them the potential to help lower overall portfolio volatility as measured by standard deviation.

Subscribe to the Invesco Canada blog and get Kristina Hooper’s market reviews in your inbox.

The opinions referenced above are those of Kristina Hooper as of Aug. 28, 2017. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.

The information provided is general in nature and may not be relied upon nor considered to be the rendering of tax, legal, accounting or professional advice. Readers should consult with their own accountants, lawyers and/or other professionals for advice on their specific circumstances before taking any action. The information contained herein is from sources believed to be reliable, but accuracy cannot be guaranteed.

Commissions, management fees and expenses may all be associated with investments in mutual funds and exchange-traded funds (ETFs). Trailing commissions may be associated with investments in mutual funds. For mutual funds the indicated rates of return are the historical annual compounded total returns, including changes in share/unit value and reinvestment of all distributions, and do not take into account sales, redemption, distribution or optional charges, or income taxes payable by any investor, which would have reduced returns. For ETFs unless otherwise indicated, rates of return for periods greater than one year are historical annual compound total returns including changes in unit value and reinvestment of all distributions, and do not take into account any brokerage commissions or income taxes payable by any unitholder that would have reduced returns. Mutual funds and ETFs are not guaranteed, their values change frequently and past performance may not be repeated. There are risks involved with investing in ETFs and mutual funds. Please read the prospectus before investing. Copies are available from Invesco Canada Ltd. at invesco.ca

These are the personal views of the author as at the date indicated, and not necessarily the views of Invesco Canada. The views expressed above are based on current market conditions and are subject to change without notice; they are not intended to convey specific investment advice. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. Although such statements are based on assumptions considered to be reasonable, there can be no assurance that actual results will not differ materially from such expectations.

Products discussed on the Invesco Canada blog page are available to Canadian investors only.

Most PowerShares ETFs seek to replicate, before fees and expenses, the performance of the applicable Index, and are not actively managed. This means that the Sub-advisor will not attempt to take defensive positions in declining markets and the ETF will continue to provide exposure to each of the securities in the Index regardless of whether the financial condition of one or more issuers of securities in the Index deteriorates. In contrast, if a PowerShares ETF is actively managed, then the Sub-advisor has discretion to adjust that PowerShares ETF’s holdings in accordance with the ETF’s investment objectives and strategies.

Invesco Intactive Accumulation Portfolios are Invesco Canada mutual funds that invest in a portfolio of underlying Invesco Canada mutual funds and exchange-traded funds. Tactical asset allocation strategies are used on a portion of the Invesco Intactive Accumulation Portfolios. The corporate class versions of the Invesco Intactive Accumulation Portfolios invest in Series I units of these Portfolios.

†Invesco Fixed Income (IFI) is a unit comprising Invesco Senior Secured Management, Inc. of New York, U.S, Invesco Advisers, Inc. of Atlanta, U.S.; Invesco Asset Management Ltd. of London, U.K.; and Invesco Canada Ltd. of Toronto, Canada.