The first estimate of Q1 US GDP growth came in at 2.3% on Friday afternoon, slightly ahead of consensus expectations but much lower than the 2.9% seen in the previous quarter. Some may see this as a disappointment and a further sign that the global economic recovery is slowing. However, we believe Q1 GDP numbers have structural flaws, which means that the US Federal Reserve (Fed) is unlikely to reverse their plans for the trajectory of interest rates.
Excluding this year, the Q1 GDP reading has missed median consensus expectations in each of the last eight years, largely driven by seasonality issues. Research from Deutsche Bank highlights that Q1 estimates have typically been 0.46% too high on average over the last eight years, and 0.64% too high over the last five. However, this is only part of the problem. It is well known that first estimates are often subject to substantial revision. Indeed, US real GDP growth has been revised up in four of the last five years and in five of the last eight years, by an average of 0.88%. Ultimately, the US economy is therefore likely to be performing better than the numbers suggest.
A mature cycle
We believe this current phase of global growth – with the US remaining a key component – has further to run. However, we are also in no doubt that we are in a mature phase of the economic cycle. From the beginning of 2009, we have enjoyed nearly a decade of QE-driven growth, but this cycle has also exhibited very different characteristics to previous recoveries. It has been very much a ‘lower-for-longer’ style cycle.
This is another reason why a lower US GDP growth figure in Q1 should not be necessarily seen as a disappointment and it is supported by history. Over the last 30 years, the average growth rate for Q1 US GDP growth has been markedly lower than other quarters and this underperformance has worsened since the start of the financial crisis.
Average 30 year US GDP growth rate
Source: Macrobond, ING as at 24/04/18. Annualised quarter-on-quarter growth rate.
Therefore, even if investors do have concerns around an economic slowdown, in the context of history, the current reading of 2.3% is actually a pretty strong number.
The Fed's trajectory
We expect the Fed to continue with their plans for two further interest rate hikes in 2018. This suggests to us that the risks to global government bond yields are to the upside relative to consensus expectations, which could put some asset prices under pressure. This is because we believe the global economic recovery has some time left to run, with recent market falls driven more by negative sentiment than an actual deterioration in business conditions.
The LF Canlife Global Bond Fund has maintained its overweight in corporate bonds in this environment. In particular, we have a significant exposure to the Financials sector, which stands to benefit as interest rates rise. In this low-but-rising rate environment, we also believe that holding the appropriate mix of currencies is essential, as it can substantially add to total return. Our largest weighting therefore remains in US dollar-denominated bonds, as we expect the dollar to strengthen versus sterling over the rest of 2018. We have also increased our weighting to the Japanese yen this year, as Japan’s growing economy should underpin further strength in the currency.
Past performance is not a guide to future performance. The value of investments may fall as well as rise and investors may not get back the amount invested. Income from investments may fluctuate. Currency fluctuations can also affect performance.
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CLI01188 Expiry 27 April 2019