December 2016

• Just how bad was 2016? We won’t know until we can compare it to 2017! Despite the reality of better global living standards than ever before, today’s world (particularly in the West) is suffering from a prevailing sense of angst and frustration. Globally the Chinese are the least gloomy: 41% of them think that the world is getting better. However, in Saudi Arabia, the US, Germany and France (the most pessimistic country), the downbeat numbers are respectively 16%, 6%, 4% and 3%. What explains this disconnect between what so many of us think about the state of the World and the reality? It goes beyond the endemic negativity bias that plagues us all: our perceptions are shaped by expectations, which increase in proportion to our living standards. In addition, computing the improvement “on average” is meaningless for those whose expectations have been shattered by stagnant real incomes and a growing sense of unfairness. In politics, like in economics and finance, everything that matters takes place at the margins.

• After years of monetary easing and ultra-low interest rates, monetary policy has ceased to be the only “game in town”. This, combined with the anticipation of fiscal activism, is pushing yields and inflation higher. The fundamental question is: by how much will interest rates rise? As US interest rates creep higher, others will follow. However, powerful structural factors will continue to exercise downward pressure on global yields: ageing, rising inequalities, low productivity growth, concerns about what the future holds and the concomitant rise in savings, etc. The conclusion: yields will rise, but historically low interest rates will persist.

• In the coming months, the dollar strength will be one of the dominant “economy stories”, with farreaching global implications. At a macro level, it will put renewed pressure on overleveraged EM with high levels of dollar-denominated debt that rely on volatile capital flows for their financing needs. At a micro level, it will make life for US exporters more difficult, and conversely favour European and Japanese exports. It will also complicate China’s economic policy by endangering the authorities’ efforts to stabilize the yuan exchange rate, possibly forcing them to tighten monetary policy at a time when the debt to GDP ratio is at a record high (250%). Default risks will consequently rise. Fitch estimates that Chinese nonperforming loans (NPL) stand at 15-21%, versus an official number of 2%. These tensions are exacerbated by capital outflows, which totaled USD530bn in the first ten months of 2016. . .

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