After a year of very strong performance in global equity markets, with mixed performance in government bond markets, we are likely to see more subdued and more volatile conditions through the end of this year extending into early 2018. Valuations in global equities are stretched, as is the bar that has to be reached in terms of earnings performance.
Over the rest of 2017, monetary policy is likely to gravitate towards tightening. Last week the Federal Reserve confirmed its intention to shrink its balance sheet, beginning in October and continuing throughout 2018. The Fed also indicated that it is likely to raise interest rates at the end of this year. We expect the ECB to announce a tapering of its assets purchase programme in the fourth quarter, commencing in early 2018. The Bank of England also appears likely to raise interest rates in November. A simultaneous tightening of global monetary policy could weaken investor confidence and interrupt market performance.
There are three risks that we are focused on for the final quarter, any of which could challenge the backdrop of moderate growth, low inflation and accommodative monetary policies that have underpinned the strong performance of risk assets over the past year.
First, growth in China is likely to weaken. If it weakens more than expected, some confidence in world economic activity may begin to dissipate. Second, as discussed, central banks are likely to tighten monetary policy. Third, we have reached near full employment in the United States, the UK, parts of Europe and in Japan. In any of these economies, inflation could pick up. If it accelerates and at the same time global growth peaks, investors may be confronted with the prospect of tighter monetary policy just as growth and earnings dip.
In light of these factors, we have reduced risk in our portfolios. In our securities based portfolios, we are reducing exposure to directional movements in global equity and bond markets. In our relative return strategies, we maintain exposure to equities but selectively through emerging markets, Europe and parts of the Japanese equity market. We seek to match that exposure with capital preservation in the form of smart carry, namely fixed income positions that are short duration and therefore less impacted by fluctuations in bond markets. We also think it makes sense to marry alternative risk premia such as merger arbitrage into our portfolios. In our view, the blend of equity beta, as well as some non-directional strategies, will serve investors well going forward.