Investors are facing another eventful year in 2017, with a continued focus on global politics and interest rates. As discussed earlier, investors have enthusiastically embraced the potential for Trump’s policy to kick-start the United States (US) economy. Much of the policy detail is still to be released and risks remain around the potential response from investors should there be any problems.
A deeper analysis of Trump’s fiscal policies has caused investors to contemplate that a new environment of higher interest rates may be emerging. The prospect of Trump’s infrastructure spending and tax cuts pushing up inflation may prompt the US Federal Reserve to raise interest rates quicker than forecast. It is uncertain how investors would respond after being accustomed to lower interest rates for so long.
On balance, a steady and expected increase in interest rates can be digested by financial markets. However, a sharp, unexpected, increase in response to higher inflation is generally negative for equity markets and the global economy.
Global politics will also be major factor during 2017, with both Brexit and Trump surprising investors last year. The next phase of this European political regime shift is likely to play out during 2017, with major elections in France, the Netherlands and Germany. The risk of more countries leaving the European Union will be front of mind for many investors given the Brexit result last year.
There also remains a risk that President Trump’s erratic behaviour may cause tensions with other countries. Trump’s economic policy has generally been “pro US” at the expense of other countries and this may also impact global economic growth.
Expected returns on Australian and international equities have reduced for this year post the strong rally after the US election. Equity markets would benefit from a period of consolidation to digest Trump’s economic policy and remain susceptible to volatility surrounding global politics or interest rates. Appropriate diversification across asset classes and investment strategies will provide the best opportunity to navigate this environment.