The current economic cycle has been going on for a long time, and global growth has slowed somewhat. Interest rates have again fallen to almost non-existent levels, while the stock exchanges began the year with a surge. In Sweden, the krona continues to fall.
According to Catella Fonder’s fixed income manager Thomas Elofsson, the Swedish government should now slacken the reins and allow a budget deficit. This kind of more expansionary fiscal policy could, in turn, be offset with slightly higher interest rates – which would support the krona.
The concept of an economic cycle no longer has the same meaning as before, since the Western world has largely moved production to countries with lower wages. The peaks and troughs seem to be shorter and less pronounced, and a longer time passes between those occasions when the market is really euphoric or really gloomy.
The last time things looked really bleak was during the financial crisis in 2008, and before that it was in the wake of the dotcom bubble in 2000. Both of these slumps were caused by asset bubbles, which is still something to be vigilant about in the future, according to Thomas Elofsson.
”What we should be careful about is if there are excesses in some sense,” he says.
In terms of future growth, this will be driven by factors such as the number of hours worked, how companies utilise their capital stock and innovations. The number of hours worked is in turn determined, at least partly, by the size of the labour force. Swedes, just like the populations of other similar countries, are not bearing children at the same pace as in developing countries. Although we are living longer and longer, we still retire relatively early, so the pure demography does not lend support to strong growth.
Several of the world’s central banks have begun to strive towards a normalisation of interest rate policy following a long period of extremely low rates combined with asset purchases. However, the process is tricky; every tightening is perceived to increase the risk of a recession, while each retreat is instead followed by euphoria in the markets.
On the fixed income side, you are often earlier than the equity side to reveal weaker times. You noted that spreads widened in the autumn, but in the first quarter the spreads on high-yield bonds narrowed quite a lot again.
”We have constantly said that the compensation is a little too low, but the same really applies to all assets and is a consequence of such a low interest rate environment. The stock exchange has done very well, which suggests stronger growth. Credit spreads have been narrowing – this also suggests strength to come. This is not as obvious in commodities, but the overall picture is not that the market is pricing in a recession,” says Elofsson.
Interest rates in Sweden are incredibly low again, but does it really matter if the interest rate is 0.5 percent or 0.1 percent?
”No, it’s probably more about the direction and whether there is a switch from one position to another. If you go from 0 percent to 1 percent, it’s quite a tightening, and vice versa.”
In the US, the ten-year bond yield has gone from 1.4 percent in July 2016 to almost 3.2 percent in the fourth quarter of last year, and is now around 2.5 percent. Thomas Elofsson said at the beginning of the year that he believed the next change in the US would be a reduction in the policy rate, and he is sticking to that.
”They have communicated that they are quite satisfied with this level. But in the background, inflationary pressures are very low and the rate of growth is on a downward slope, so I think the next move will be a reduction. This has already been priced in by the market,” he says.
Much of the past year has revolved around the trade conflict between the US and China, with talks ongoing, but no solution has yet been presented. There is also a presidential election approaching in the United States next year, with Donald Trump trying to stay on for another four years.
”These things are connected. When there are presidential elections in the US, everything is governed by the economy, and what must not happen if you want to be re-elected is for there to be a recession. This suggests there will be a resolution to the trade conflict,” says Elofsson, adding that the election may also influence the Fed and the interest rate.
”The central bank does not usually want to raise or lower rates ahead of an election. Which means that if they do anything it will have to be during the autumn.”
The US budget deficit has continued to grow under Trump, and is at a high level. The question is whether the deficit could cause the next big meltdown, economically speaking. Thomas Elofsson sees the risk, but does not consider it particularly high. However, he points out that the deficit has largely made it impossible for Donald Trump to implement stimulus measures ahead of the election.
”A surplus would have been better, which would have made it possible to pursue some fiscal policy. Trump would have been able to do that for the election, but he has used up the opportunity. This might be why he is so vocal about the Federal Reserve and thinks they should lower the interest rate,” he says.
US stock exchanges have been extremely strong this year, helped by analysts cutting their earnings forecasts ahead of the reports for the first quarter. The stock markets have also been greatly fuelled by share repurchases, a measure that Florida’s senator Marco Rubio has proposed to tax.
”The money has to be returned to shareholders, and either you distribute it or you buy back shares, which is more tax efficient. The buybacks are a consequence of strong cash flows,” says Elofsson.
In China, the focus has been on the country’s growth, which is contracting and has sometimes given the impression of having slowed down relatively abruptly. This has led the country’s leadership to implement an expansionary policy, which has now been in place for almost a year.
”These stimulus measures are now starting to become apparent, in some monetary measures and other things. A good guess is that global growth will continue to fall, but that things will start to look better in the second half of the year or some way into 2020. This is mainly being driven by China,” says Elofsson.
What about Europe? Germany is having a slightly tougher time and we are seeing problems in the UK and France, with the yellow vests and unrest in France and Brexit in the UK. Germany and the UK are two of Sweden’s largest trading partners.
”As far as Brexit is concerned, we have to believe they will resolve it. I have difficulty believing that the British will stop going to the football, drinking beer and eating pies. There are certainly difficulties in these countries. On the other hand, we have such an incredibly weak currency, which is very good for exports. Although over time it cannot be successful for a country to weaken its currency – rather the opposite,” says Elofsson.
That has been driven by Riksbank Governor Stefan Ingves, who wanted import inflation. Has he painted himself into a corner so that we are stuck with an extremely weak currency? Some people have argued it has gone so far that we are unable to get the currency back up.
”It is difficult to see that the krona will strengthen in the near term, and it would require a policy adjustment. If we could pursue some fiscal policy and have a budget deficit, this could actually be offset with slightly higher interest rates, and surely that would be the best thing. I think that would be a very good environment for the krona.”
Elofsson believes that the extremely low cost of capital in most countries will persist for a long time. However, fiscal policy differs between countries – while Sweden has pursued a tight policy with budget surpluses since the crisis of the 1990s, countries like the US, China and India are adding more fuel.
”This is really a slam dunk for Sweden. I think there will be some easing during this term, and there could be tax cuts for people on low incomes or investments in infrastructure,” says Thomas Elofsson.
We should add a little to the debt mountain in Sweden?
Asset inflation has been extremely high in many parts of the world in recent years, and not least in Sweden. Consumer inflation is carefully measured, while the extreme asset inflation created by the low interest rates passes by unnoticed.
”This is the big threat in the long run. What has been happening for a long time is that owners of capital have taken a greater share of the value added. In a society, everyone needs to be included and this is tough for anyone who lacks education or cannot do qualified work – it needs to be resolved in other ways,” Thomas Elofsson.
But could this swing the other way, with a switch from asset inflation to consumer inflation?
”In some sense, that would be a dream scenario, but it’s not very likely. However, the most favourable time for globalisation, with the relocation of labour, has probably come to an end and Trump seems like an expression of that. It’s a undercurrent that seems quite widespread,” says Elofsson.
The issue of future investment levels has often been under discussion, and some pundits have been anticipating an investment boom. However, according to Elofsson, it can be difficult for companies to assess what investments will pay off, and when it is appropriate to make them. The climate is one example of an area where a lot needs to be done going forward, but it is not certain that companies will generate the same return from investing in the climate as they have historically received from other investments.
Other factors may also be creating uncertainty about future investments.
”Brexit is one such factor – when the outcome is unknown, it is difficult to make the investments you imagined. So, you wait. And it’s the same with the trade problem between the US and China; when things are uncertain, investments get postponed,” says Elofsson.
Catella’s fixed income portfolio managers have previously predicted that the Swedish Riksbank would increase interest rates this year and follow up with another hike. The first increase was made, but, in its latest announcement, the bank changed the interest rate path and pushed further increases down the road. However, Elofsson still believes that there may be another increase, even though there is some evidence to the contrary.
”They are getting a bit late. The ECB says it will give more stimulus and the Fed expects to sit tight. So it is very difficult to imagine that the Riksbank will raise rates. But this could change quickly, and I think they really want to get into positive territory. They could probably make one more increase, if they get a move on,” he says.
The Riksbank also said they will buy government bonds for SEK 45 billion in the autumn. Is that realistic?
”Somehow, all of this is unrealistic. When you dig a hole like this, it is extremely difficult to get out of it. What they want is to begin normalisation – a process that takes forever and is a bit like watching paint dry. We are on the way, but it will take a lot of time before the policy rate is at 3 percent. I hope to see it during my lifetime, but I am not sure I will.”
Sweden’s National Institute of Economic Research stated in its latest assessment that Swedish household consumption has increased over the past three years, while the savings ratio also increased. But disposable income is falling. The question then is, what happens to consumption going forward.
Elofsson points out that, as far as different age groups and education levels are concerned, some people are having a tough time. They cannot consume more because they lack the income. Then there are others who are fine, but may not be consuming as much as before and are choosing to save.
”Methods to increase consumption are intended to make sure that those who have the lowest incomes do better. The easiest way is to give them money from the state, but the long-term solution is for them to train. Consumption will probably be a bit sluggish – many people do not have the means, and those that do have the means are already consuming as much as they want,” says Elofsson.
From the outside, the macroeconomic situation created in Sweden over successive years seems to be difficult to change. Debt is high and, even though the Riksbank would like to get inflation started, it has so far been more easily said than done. This may point to a period of slower growth, combined with continued low interest rates.
Nonetheless, Elofsson expects higher inflation in the future, but emphasises that it is almost impossible to say when this will happen.
”Inflation is very much about perception. It is pivotal whether you expect 2 percent wage increases or 10 percent. There is no silver bullet but, when the last resource is exhausted, prices will rise. And, in the long run, inflation should be higher than it has been over the past ten years. When this will happen – next year or in ten years – is hard to know,” he says.
We have low interest rates and will remain there, with extremely marginal increases? And will buy even more shares and properties at lower yields?
”That’s my best guess. Growth is slowing somewhat, inflation remains low and normalisation takes a long time. We are getting healthy corrections on the stock market, sparking fears of a recession, but the central banks know that a recession would leave them in a very difficult position.”
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