What can we expect from the economy in 2017? BofA tells all

Top five macro calls for year ahead

Next year is just around the corner, and there could be many changes coming to economy as President-elect Donald Trump prepares for his time in the Oval Office.

Bank of America Merrill Lynch Global Research issued its outlook for 2017, and its experts are moving forward with cautious optimism.

“The outcomes of Brexit and the U.S. election have brought fundamental change, which equates to investor opportunity,” said Candace Browning, head of Bank of America Merrill Lynch Global Research. “If investors choose asset classes, sectors and stocks carefully, they can meaningfully outperform the market. 2017 could be the year of the active investor.”

According to the bank, politics shifted in a backlash to globalization. This is seen through Brexit, the election of Trump and the Eurozone, and raises questions about trade policies that would affect government debt levels, rates, commodity prices and economic growth rates, particularly in emerging markets.

This could mean a change in tone during 2017 in regards to the investment cycle. So, here’s the bank’s top five predictions for the coming year:

1. S&P 500

A 2017 year-end target for the S&P 500 Index is pegged at 2300, which assumes a 5% gain for the year and earnings growth of 9%, or a 2017 earnings per share forecast of $129. The case for a traditional, euphoria-driven end-of-bull-market rally could put the S&P 500 as high as 2700, in line with historic norms of 20% or greater annual returns. A bearish scenario, in the event of recessionary returns, could put the S&P as low as 1600.

2. Inflation: The party has started

Inflation in the U.S. is expected to increase to 1.9% by the end of next year, approaching if not overshooting the Fed’s 2% target. Although the inflation party started elsewhere in the world, Europe didn’t get an invitation. The Eurozone 10-year and 20-year inflation break-even jumped recently, nearing the European Central Bank’s “below but close to 2%” target, yet the ECB could disappoint by tapering prematurely or not extending quantitative easing beyond next March. 

3. Rates: Monetary easing gives way to fiscal easing

The history of populism is one of fiscal largesse. U.S. rates have backed up quickly after the election, driven largely by a repricing of inflation expectations. With long-term inflation break-evens closing on their historical averages, we think the next phase of the rates move will be led by the belly of the curve and real interest rates. The market expectation for Fed hikes in the coming years has sufficient room to increase relative to the current projections in our view.

4. Energy: OPEC resets the bar

For the first time in eight years, OPEC agreed to cut crude oil production, marking a turning point in the price war at the center of cartel politics. As a result, our 2017 forecasts are unchanged, leaving WTI crude oil at $59 a barrel and Brent to average $61 a barrel. Pricing forecasts embed a sequential 500,000 barrel-per-day increase in U.S. crude production, raising domestic output to 9.2 million barrels a day by the end of 2017.

5. Credit: Farewell to utopia

After an extraordinary year for credit investors, total returns in 2017 will likely be a sobering 3.5% to 4.5% for U.S. high-grade bonds and 4% to 5% for U.S. high yield. Still, our preferred asset class is U.S. high-grade, where the drop-off in supply could be very bullish. On the other hand, high-grade corporate spread maturity curves may super-flatten as global credit investors sell shorter maturities and buy the long end. A modest 20 basis points of spread tightening in 2017, generating a healthy 3% to 4% excess and 3.5% to 4.5% total returns, is expected. Corporate balance sheets are improving in the U.S. as earnings headwinds dissipate. Thirty-year corporate bonds could generate total returns of 8% percent to 9% in 2017.

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