Abby Cohen Is Bullish On U.S., India, China, Brazil And 2017: An Exclusive Interview
Goldman Sachs’ Abby Cohen on U.S. elections, Fed policy, emerging market flows and 2017.
The minutes of the September meeting of the Federal Open Market Committee (FOMC) suggest that several of its members believe a rate hike is needed ‘relatively soon’.
Several members judged that it would be appropriate to increase the target range for the federal funds rate relatively soon if economic developments unfolded about as the committee expected.FOMC - Minutes of the September meeting
Yet that’s no confirmation the Fed will hike the interest rate this year.
It was noted that a reasonable argument could be made either for an increase at this meeting or for waiting for some additional information on the labor market and inflation.FOMC - Minutes of the September meeting
But the labour market and inflation indicate that the U.S. economy is ready for another rate hike, says Abby Cohen, senior investment strategist at Goldman Sachs and one of Wall Street’s most renowned market experts.
In an recent interview in New York Cohen spoke to Bloomberg Quint’s Menaka Doshi about global economy, U.S equity markets and emerging market flows.
Fed Rate Hike In December?
What’s your assessment of where the U.S. economy is? Do you think that the Fed feels confident about the recovery of the U.S. economy to consider a second rate hike in December?
The situation in the U.S. economy is actually good. Though it might come as a surprise to people who pay attention to political debates in the United Sates. Economic growth in the U.S. is probably in excess of 2 percent; not bad for such a huge economy. Unemployment is now below 5 percent and now we are seeing that incomes and wages have been rising. That’s good in terms of durability of economic growth. This Fed would like to increase the interest rates but not before they need to. And amongst the things that they are looking at are not just the domestic conditions but also global conditions and I think this has been a factor and that is why they have waited. Our expectation is that there is a better than a 50 percent chance that they will again raise interest rates, but not likely until after the elections, so that would be the December FOMC Meeting.
Inflation Moving Higher?
You spoke of the global scenario - there is some data now that seems to suggest that the estimated increase in consumer prices across the world is now at about 1.3 percent. And many experts are saying that this wards off any threat of potential deflation. Would you agree with this assessment?
Many central banks have a target for inflation of about 2 percent, so we are still below that. One of the key elements over the next few quarters would be what happens to the energy prices. We have seen for example in the United States that our Consumer Price Index has been held down by lower energy prices, but as they move up we would expect the CPI to move to about 2 percent. Core inflation would be something that the Fed would spend much time looking at, including the metric in the United States that’s called the deflator for personal consumption expenditures. We are not yet at 2 percent but we have been moving higher.
Need Fiscal Support
Do you think the threat of global recession has for now been warded off? Are you still worried about the systemic weakness in the Eurozone?
Our economics team based in Europe and U.S and elsewhere isn’t concerned about there being another slip into recession. We see monetary policy in many countries is trying to be very stimulative and what we will be looking for is movements in the fiscal policy. I think this has been something that has been unnecessarily absent in the discussions in the United states. For example, we are hearing many more calls for an increase in infrastructure spending. In Europe as well, there is less discussion about the so-called zero interest rate policy constraints but much more discussion on what should and could be done by governments to increase their spending to enhance economic growth.
U.S. Election Impact On The Economy
Let me talk about the U.S. and the impending election. It’s not clear what the economic policies of both candidates are. What’s your assessment? What are the likely economic scenarios of a Trump victory or a Clinton victory?
We have much more information about what the Clinton presidency would look like. She has been more forthcoming about the details. When we look at what they have provided and look to a series of nonpartisan think tanks and experts in tax policies, what seems clear is that Mrs. Clinton’s proposals would be much more balanced. Yes, some increases in taxes, particularly for upper income individuals, but we also know that the spending is largely matched with those increases in revenue. Not so much is the case for Mr. Trump where most of the outsiders are suggesting that the national deficit would increase tremendously under Mr. Trump’s proposals.
U.S. Election Impact On The Fed Decision
You said
right at the beginning that there is a more than 50 percent chance that
the Fed would do another rate hike in December, after the elections are done. Do
you think the chances would remain the same if it were Donald Trump who became president? Do you think that would change the way the Fed would look at the economy?
Despite the comments made by some politicians, we think that the Federal Reserve has to make decisions in an apolitical manner. We believe the decision would be made based on the economy per say. Now, what is already built into the market is the expectation of another rate rise, hence more than 50 percent. Our team thinks that the odds are close to about 65 percent, because they look at an economy which is probably accelerating. We are seeing some strength now because of inventory rebuild and the consumer is looking better as well.
Emerging Market Flows
Do you expect the repricing of emerging market investments if the Fed were to hike rates in December? You see more money rushing back to the U.S.?
We have seen emerging markets perform quite well since the summer. I think the average is up something like 12-13 % and we think this is likely to continue. Keep in mind that there has been a great deal of movement into the emerging market from investors in the developed market who are feeling more comfortable with their home market. You know the very strong co-relation is that if the home market is performing well the investors there are more confident and are willing to take more risk.
We believe that these flows and more stimulative policies that we are seeing in a number of developed economies, is to the benefit of emerging markets.
We have seen a great deal of money going to India, India is now overweight by most investors who specialise in emerging markets and our research team think this is appropriate. Strong economic growth, good long term outlook for India suggest that that’s a good place to be.
Our team would also suggest at this point in being overweight in China and this is against the grain of the consensus. The consensus is now less underweight than it used to be 6-12 months ago. Our team is suggesting an overweight. And the other area we are seeing consensus move in a more positive direction is Brazil, where investors are saying it has gotten cheap enough. So it becomes a question of what is priced in to the market, and investors by and large who specialise in emerging market are saying there is an opportunity there because of the valuation.
India vs China vs Brazil
That’s interesting that you brought that up. It suggests that your team is more confident about the Chinese government being able to balance the restructuring process underway. Brazil has been through so much political turmoil and if both these markets look attractive, then do you think that fewer flows will go in to markets like India, where everyone is overweight and the conversation now has moved towards overvalued?
Well all I can say is what our team are recommending, and they are recommending an overweight in India and an overweight in China. But we are seeing some other investors becoming interested in establishing larger positions in some of these other markets as well.
In the beginning of the year, in a series of interviews, Abby Cohen said she expected the S&P 500 to be at about 2100 at the end of the year. She also opined that China would not undergo a hard landing and based on the Goldman Sachs estimates estimated crude oil prices to recover to between $50-60. All three calls have turned out right.
The Gold Rally - What Explains It?
All the calls you made in the beginning of the year have turned out to be absolutely bang on and no surprises there, what but interests me is that whilst all of these strike a note of confidence, we have also seen a big rally in gold prices. And that sort of contradicts the confidence that people may have in underlying economies and equity markets. What explains the rally we have seen in gold?
One thing I would mention here is that it tends to be the emerging market participants, particularly those in India and China, who are more interested in gold. Gold is not a major asset category for institutional U.S investors but it is viewed as a stored value particularly for those based in the emerging markets, who for cultural reasons and also for risk avoidance reasons like gold. I tend to look at it as an industrial commodity and not much more.
So you are not reading much into the fact that people are putting money into gold. Is it due to some sort of uncertainty about where the world is headed? Because you alluded to the large amount of money that earns negative interest rates. And there is a great degree of fear, because this is the first time the world is seeing something like this and nobody knows where it’ll end. Is gold a reaction to that? Is gold a reaction to the political uncertainty in the U.S.?
Yes and yes.
The Negative Interest Rate Folly
Alright, that’s the short answer. What do you expect would be the outcome of such a large amount of money earning no money, in Europe and many other parts of the world including in Japan?
One thing that the central banks have to come to grips with is the idea that negative interest rate may not be such an effective policy. In some countries it has turned out to be a true folly. For example, when Japan moved to negative interest rates last January one of the things that the Bank of Japan (BoJ) said very specifically is that they were hoping that this would encourage more wage inflation. Yet that was followed shortly thereafter by a statement from the Japanese labour unions themselves that they were going to be asking for a lower wage inflation than previously thought, because of the negative interest rates.
Where we have seen potentially some benefits from negative interest rate mainly has come through, in my opinion, through the foreign exchange channel. Negative interest rate has led to a reduction in the value of the currency and hence that nation has become more competitive on a trade basis. That to me has been the main mechanism. What we are seeing of-course are, as you pointed out, some of the peculiar decisions that are being made, because negative interest rates is hard for those who are naturally savers to put money into banks when the returns are, shall we say, poor or non-existent. We have also not seen a particularly large increase in borrowing, which had been the intent. So I think what we need to be thinking about is a more comprehensive approach to economic stimulus and as we discussed a lot of that could come in the form of fiscal stimulus.
2017 - Better Or Worse?
And if it doesn’t come through as fiscal stimulus? Because we continue to see political uncertainty, we have seen it with Brexit, we are seeing it in Italy, we are seeing it in Greece again, what happens next year?
2017, thus far to our economics team, looks like a year of economic growth. It’ll be below potential in a number of countries, perhaps not the United States, and that is likely good news. We are the world’s largest economy and we are also the world’s largest importer and so if we are strong that benefits many of our trade partners as well.
One final question Abby, what do you expect the next year will hold for the equity market in the U.S, for commodities which seemed to be bottoming out including oil prices, and where do you see the fixed income market, where do you see rates?
Alright, quickly - for the U.S we see the rates higher, we see equity prices higher as well. We think they will move up largely in relationship to growth and earnings and we believe that the economy will continue to do well. More jobs, created perhaps at a slower pace than they are being created right now, but we do think that wages and family income will continue to rise and ultimately that is what gives any nation a period of economic growth.
And some of that confidence extends to emerging markets as well?
Yes.
This interview was done before the release of the minutes of the FOMC September meeting.