2 key risks to the economic outlook

Signs of economic growth amid easier monetary policy should benefit investors over the medium term, although the outlook comes with a couple of key risks.

“It’s definitely a constructive growth outlook,” said Michael Sager, managing director and head of multi-asset and currency management with CIBC Asset Management, in an Oct. 15 interview. 

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Growth has been particularly strong in the U.S., Sager noted, with the economy growing at a nearly 3% pace, compared to its long-term growth rate of 2%. U.S. consumer spending has remained resilient, he said, and U.S. monetary and fiscal policies are supportive of growth.

Other major economies exhibit a similar pattern, with supportive policies and global investment spending acting as “a tailwind to growth,” he said.

In Canada, consumer spending and business confidence have been “relatively resilient,” he said, despite a weaker labour market compared to the U.S.

The risks to his constructive outlook for economic growth are twofold, he said.

“If inflation were to become a little bit more sticky around current levels, that would inhibit policy easing,” he said. That in turn, “would keep interest rates higher than the market expects and would inhibit the growth outlook.” 

The second risk is political risk, such as the upcoming U.S. election.

“A Republican sweep would have very different implications for policy versus a Democratic sweep,” Sager said. 

For example, a Republican sweep would likely lead to more aggressive trade tariffs, particularly toward China. While Democrats have a similar view on reducing U.S. economic reliance on China, they have a less aggressive tariff approach.

“That would be an important difference that would have implications for interest rate policy, inflation and growth — at least at the margin,” Sager said. 

A Republican sweep would also likely mean a focus on deregulation, which would affect certain sectors more than others. “Think about finance and energy being particular winners under a Republican sweep that leads to aggressive deregulation,” Sager said.

As things stand, “it remains very uncertain who’s going to win the presidential election, and whether we’re going to have a divided government,” he said.

Given his constructive outlook for growth, as well as for inflation, Sager said a balanced portfolio represents opportunity.

“Yields on fixed income have risen back to interesting levels from very low levels a few years ago,” he said. “The diversification benefit that fixed income offers now relative to equity is also very attractive.”

He also noted that his constructive growth outlook would be positive for corporate earnings and, thus, for equities broadly.

“Whether you’re a fixed-income investor, an equity investor or a global balanced investor, we think our constructive fundamental outlook will hold you in good stead as long as you look through short-term volatility and focus on that long-term fundamental outlook,” he said.

Turning to currency markets, Sager noted that productivity growth is a key driver of exchange rates and currencies.

“Countries with strong productivity have higher expected returns to capital, and so they attract inward investment,” he said. “And that inward investment leads to an appreciation in the value of their currency.”

Given Canada’s relatively weak productivity, the loonie is weak against the U.S. dollar, he noted.

For the euro, its shorter-term direction will depend on political risk, he said. For example, if a Republican win in the U.S. results in aggressive tariffs on China, the euro, which is highly dependent on China, would be adversely affected. Also, the eurozone, as an auto producer, could potentially be subject to U.S. tariffs.

“The outlook over the next three or six months for the euro is weak versus the U.S. dollar, and sideways against the Canadian dollar,” Sager said. 

Regarding the Japanese yen, Sager noted that the Bank of Japan is bucking the global central bank trend by tightening monetary policy, which would be supportive for the yen.

The yen also tends to be a safe haven currency, he noted.

“If [the] political risk factor becomes more relevant, the yen, along with the U.S. dollar, will likely be a beneficiary in the short term,” Sager said. 

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