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#Market Strategy — 15.05.2018

Economic Outlook Update

Guy Ertz

Global growth to stabilize above potential level in 2018 before decelerating in 2019. Renewed trade tensions are the key risks.

United States

The US economy continues to boom. With GDP growth forecast at 3.1% in 2018, the economy is entering its ninth year of expansion. We nevertheless expect a slowdown in the expansion in 2019 with a growth of 2.1%. The economy is also beginning to show a few signs of tensions, which are likely to encourage the Federal Reserve to continue tightening its monetary policy gradually. The fiscal impulse is taking place at an advanced stage in the recovery, at a time when the utility of such a move is open to debate.

At a time when bank regulations are likely to be rolled back, the credit cycle is once again nearing its end: consumer loans reported record-high growth in fourth-quarter 2017. We still expect that the tax cuts would add 0.5% to the GDP growth this year. The job market is finally showing strength and its first signs of tension with growing participation rates. Wage growth is accelerating and now largely surpasses price increases. We expect inflation to continue rising in 2018 to reach 2.3% before diminishing towards the Fed target around 2.1% next year.

Tensions are bound to arise, and monetary policy must be adjusted in consequence. Our view is that the Fed will hike four times this year given strong economy and signs of inflation. We however expect only one rate hike next year as the economy should decelerate. The terminal rate would therefore be 2.75%.

The Eurozone

The economy is expected to continue growing at a robust pace this year. We expect GDP growth to reach 2.6% in 2018 before slowing at a level of 2.1% in 2019 in line with the global economy. This would still be a very strong performance. Furthermore, the dispersion of economic performances among member states is receding. The economic momentum has slowed quite a bit in the eurozone but we expect it to be temporary. Robust domestic demand will be the main driver. Household consumption will continue to make the biggest contribution to GDP growth, bolstered by job creations and a acceleration in wages. Investment will be the factor driving the expected acceleration in growth in 2018. After four and a half years of uninterrupted growth, an unemployment rate that has dropped from 12% to 8.5%, and net job creations of nearly 8 million, wages adjusted for productivity growth continue to grow at an annual rate of less than 1% and core inflation is still not showing any convincing signs of picking up. Our inflation forecast for both 2018 and 2019 are 1.7%. Spreads in the periphery countries are decreasing thanks to the strong recovery that is also happening in those countries. Uncertainty over the level of the output gap and the potential growth rate explains why the ECB remains prudent. Indeed, our view is that the ECB won’t stop abruptly the QE therefore we expect an extension at a slower pace in 4Q18 before exiting QE at the end of the year. Policy rates would be lifted well past the end of the QE ie. 2Q19 for the deposit rate and 4Q19 for the refi rate.
 

Japan

The GDP growth reached 1.7% in 2017 and we expect it to be 1.3% in 2018 and 0.6% in 2019. The economy has seen a rebound in activity driven mainly by the international environment, but also by the expansionist policy. The yen has lost one fifth of its value in five years, probably as low as the government wants. Coupled with tax cuts, this has helped companies to boost their exports. Japan has returned to a current account surplus and the economy is in almost full employment with less than 3% unemployment. Beyond the relief brought by Abenomics, Japan’s economic challenges (demography, productivity) remain. Deflation, in particular, remains a thorny issue, with consumer prices stagnating over the last few years. Wage growth has also remained weak. We expect a modest rise in inflation from 0.5% in 2017 to 0.9% in 2018 and 2019. We expect the BoJ to keep its policy rates on hold for some time. The Central Bank could start reducing its purchases of ETFs, regardless of the level of inflation. But in light of recent volatility in the equity market, this also seems unlikely for the foreseeable future.
 

Emerging Markets

Economic growth has slowed since last summer but is expected to strengthen over the next two years as we expect the global environment to remain supportive. The rebalancing of China’s economy implies not only a lower economic growth, but also that Oil-exporting countries could be the most affected by this change in China’s growth regime. Low-income countries, especially the commodity exporters are also vulnerable as they benefited from a financial windfall, but did not improve their macroeconomic fundamentals.
 

The main risks

The main downside risk to this scenario are the trade tensions, which threaten global trade and could hurt the global economic upswing. Although multilateral trade is unlikely to implode, it promises to be more conflictual. The second, more medium-term risk is rising private and public debt especially in the US. Finally, a faster rise in inflation could prompt the Fed to hike rates more than expected. The US deficit could rise sharply, pressuring interest rates further.