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Three Surprises in 2017

Donald Trump’s economic policies are likely to produce higher US inflation and interest rates, and more dollar appreciation, than financial markets expect. But Europe could stabilize after France's presidential election, ushering in a period of healthy economic growth and strong financial performance.

LONDON – Economic pundits traditionally offer their (traditionally inaccurate) New Year predictions at the beginning of January. But global conditions this year are anything but traditional, so it seemed appropriate to wait until US President Donald Trump settled into the White House to weigh in on some of the main surprises that might shake up the world economy and financial markets on his watch. Judging by current market movements and conditions, the world could be caught off guard by three potentially transformative developments.

For starters, Trump’s economic policies are likely to produce much higher US interest rates and inflation than financial markets expect. Trump’s election has almost certainly ended the 35-year trend of disinflation and declining rates that began in 1981, and that has been the dominant influence on economic conditions and asset prices worldwide. But investors and policymakers don’t believe it yet. The US Federal Reserve Board’s published forecasts suggest only three quarter-point rate hikes this year, and futures markets have priced in just two such moves.

As Trump launches his policies, however, the Fed is likely to tighten its monetary policy more than it had planned before the inauguration, not less, as the markets still expect. More important, as Trump’s policies boost both real economic activity and inflation, long-term interest rates, which influence the world economy more than the overnight rates set by central banks, are likely to rise steeply.

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