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Risk factors, Macroeconomic context and forecasts - October 2017

SUMMARY

Risk factors

The table below presents risk factors with probabilities assigned. It also develops the most credible market impacts.

MACROECONOMIC CONTEXT - Our convictions and our scenarios

This section provides a reminder of our central scenario and alternative scenarios.

Macroeconomic picture by area

An overview of the macroeconomic outlook for world’s major economic regions

Macro and Market forecasts

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October 2017

Flag-FR
Octobre 2017

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The table below presents risk factors with probabilities assigned. It also develops the most credible market impacts.

2017.10-Risk-factors

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This section provides a reminder of our central scenario and alternative scenarios.

Central scenario (70% probability): reflation continues. The resynchronization of the cycle in all the major areas carries the global economy

  • Global resynchronization: global growth accelerated in 2017 and will remain dynamic next year. The advanced economies (with the notable exception of the United Kingdom) will continue to experience above potential growth (notably the eurozone and Japan). And the major emerging economies that were in the red (Brazil and Russia in particular) confirm their exit from recession. Finally, growth remains strong in China. The recovery is mainly driven by domestic demand. The resynchronization of the global cycle generates “multiplier effects” - via trade - that sustain the recovery on a global scale.
  • World trade: After a marked decline since the financial crisis, world trade has recovered markedly. It is now stimulated by the resynchronization of the global cycle which it feeds in return. This effect is however expected to wane: we anticipate a stabilization of the world-trade to world-GDP ratio in the future (this means that, in the medium run growth will remain primarily driven by domestic demand).
  • United States: the two topics that are currently attracting media and investors’ attention (the impact of Hurricane Harvey and the risks of a “government shutdown”) should have little impact on growth. The impact of the hurricane in Texas is expected to be temporary, as it was the case for the Sandy hurricane, for example. In addition, keep in mind that reconstruction spending will benefit to growth. As regard a potential government shutdown, we tend to consider that such a scenario - which means that the government runs out of money because of the Congress’s refusal to vote on the budget - is unlikely to happen, one year before the mid-term’s elections.
  • Eurozone: the euro appreciation goes in tandem with the recovery more than it threatens it. It is mainly through this channel that monetary conditions will start to tighten in the Eurozone. In addition, long-term interest rates should rise as a result of the partial removal by the ECB of excessive monetary accommodation. Hence the slight decline in GDP growth expected in 2018 (from 2% to 1.7%).
  • UK: the economy will slow. The negotiations of the Brexit stumble upon the very elements which are to be negotiated and the order in which they are to be negotiated. The negotiations will be difficult as the cohesion between the EU countries is strong. Against this backdrop, the Sterling remains at risk despite its recent rebound. The risk of a slowdown in the UK is underestimated. Nevertheless, we do not expect a significant impact on Eurozone growth, supported above all by domestic demand.
  • China: growth is excessively fueled by credit. Debt remains essentially domestic and manageable, but the risk remains. The current pace of growth is not sustainable in the long run. We expect a gradual deceleration of growth and a rebalancing (less growth, less debt).
  • Core inflation is excessively low at this stage of then cycle. We expect a gradual increase on both sides of the Atlantic. But inflation will remain moderate (by historical standards) in most advanced economies.There is a structural slowdown in inflation due to supply factors. In addition, the cyclical component of inflation has weakened (flattening of the Phillips curve). Ultimately, we expect a moderate acceleration in the coming years in line with the improvement of the labour market. The acceleration of core inflation is more likely to materialise in the US (full employment, rising unit-labour costs, dollar depreciation, end of the price drop on mobile phone services).
  • Oil prices: we expect oil prices to evolve in the $45 to $55 range with potential peaks outside this range ($40- $60), but we would expect these peaks to be short-lived.
  • Fiscal and tax policies are likely to become more expansionary(in the US and Germany in particular). In the US, republicans just announced the broad lines of the tax reform (that should be positive for growth in the medium run). But this reform is still far from being adopted by Congress. . In Germany, we would expect some infrastructure spending, but it will take time to form a coalition government and to reach a compromise on this controversial issue. At best, the impact on growth will not materialise before end 2018 or even 2019.
  • Central banks have changed the tone of their communication: they are more and more clearly determined to remove “excessive accommodation”: with a reduction of the Fed’s balance sheet (less and less reinvesting maturing papers) and more rate hikes than what is currently priced in (Fed). On its side, the ECB will probably announce on 26 October the reduction of its asset purchases. Having said that, monetary policies are still expected to remain broadly accommodative next year.

Pessimistic risk scenario (15% probability): global growth at about 2% or even lower

Four distinct events would be likely to drive the global economy in this scenario.

  • China: banking crisis / hard landing of the economy

• Stabilization of growth is at the expense of a sharp rise in debt, especially of non-financial corporates. This is not sustainable in the long term (significant increase in non-performing loans in banks’ balance sheets.

• Bank runs, massive capital outflows, strong depreciation of the RMB ...

• A hard landing in China would have massive spillovers on the rest of the world (emerging economies in particular).

  • A recession in the United States

• Potential growth is much weaker than in the past: the ability to absorb shocks has been weakened and the room for manoeuvre in terms of economic policy (fiscal and monetary policies) has diminished. In other words, it is easier to fall into recession in the wake of an exogenous shock. It is all the more true that the economy is mainly driven by consumption.

• Donald Trump may still surprise with protectionist measures. Such a move would increase inflation expectations, forcing the Fed to accelerate the pace of normalization.

  • A bond-market crash would trigger a fall in equity markets, which are notoriously overvalued, and this could generate expectations of recession or even a recession
  • A disorderly deleveraging (generalized, excessive and rapid) would generate new deflationary fears and the return of the spectre of “debt deflation”.

• Public and private debt continued to rise, reaching a new peak in 2016, to about 250% of GDP (US, EZ, UK, China). Should asset prices fall, deflationary pressure would rapidly resurface forcing central banks to continue or restart their QEs.

Optimistic risk scenario (15% probability): strong acceleration of global growth in H2 2017-2018

Several factors, which are likely to generate higher growth, should be closely monitored.

  • World trade has seen a dramatic decline, a decade of disruption in the 40 years that preceded it. If the current improvement (especially in Asia) becomes global, then global growth will accelerate.
  • Investment, which has been sluggish since the beginning of the post-financial crisis recovery, is moderately recovering. It is an essential engine for global trade and thus for global GDP growth. The resynchronization of the global cycle is likely to accelerate global growth.
  • A large-scale tax stimulus in the US would remove doubts about the continuation of the US cycle.
  • Continued cyclical acceleration in the Eurozone (supported by low inflation which would allow for an accommodative monetary policy for a few more years), the use of budgetary and fiscal room for manoeuvre provided by lower interest rates, and the fading political risks in the Eurozone would enable the European monetary union to emerge as a stronger and more stable growth area.

 

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AMERICAS

 

RISK FACTORS

UNITED STATES

Growth remains above potential

  • Surveys remain strong, particularly in the manufacturing sector. Growth is expected to be between 2% and 3% in Q3 2017. Nonfarm payrolls are decelerating, which is not abnormal at this stage of the cycle. However, core inflation is weak. We believe that this is due to temporary shocks on specific products and that core inflation will ultimately recover in the coming months (cyclical inflation expected to materialise).
  • Two events may muddy the waters in the coming months (Hurricane Harvey and debt ceiling). With regard to the hurricane, we estimate that the reconstruction spending will  support growth in Texas. With regard to the debt ceiling, we expect a further increase due to the proximity of the mid-term elections. For the same reason, we believe that some tax cuts will be voted in Q1 2018 at the latest, despite the political difficulties faced by Donald Trump with his own camp.
  •  A messy debt ceiling debate
  • Protectionist risk still present
  • Lower potential growth
  • Erosion of corporate margin

 BRAZIL

  • Inflation continues to recede and the BCB may pursue its monetary easing cycle.
  • Economic activity indicators are slowly improving. Real GDP growth released low but positive in Q2. Baring a new shock, Brazil should exit recession.
  • The new episode in the political crisis, which, once again, involves directly the president, may delay the vote on pension reform.
  • Fiscal easing with, in particular, a very modest pension reform
  • Rise in political risks

EUROPE

 

 

EUROZONE

 

A well-entrenched recovery with a lot of remaining potential

  • The series of upside surprises did not stop this summer: good Q2 figures and business climate indicators showed strong momentum into Q3. The recovery in investment and the rapid drop in unemployment generate a virtuous circle that will continue. Core inflation is slightly on the rise, but remains weak in terms of absolute level (1.2% in August). At this stage, the rise in the euro (which partly reflects the region’s economic improvement) does not put the recovery at risk: we increased our GDP growth forecast from 1.8% to 2% for 2017, and from 1.6% to 1.7% for 2018. Yet a rapid additional appreciation of the euro may become problematic.
  • Political risk declined sharply after the French election. However, residual uncertainty remains in Italy (general election due no later than May 2018 against a backdrop of rising euroscepticism). Germany’s attitude will not shift substantially in the wake of the elections on 24 September. The performance of the far right calls for a continued (or even more) cautious approach by Angela Merkel when it comes to new initiatives targeting an ever closer union.
  • Rise in the Euro
  • Political risk (rise in antiestablishment
    parties, notably in Italy and Germany)
  • External economic risk:
    end of the US cycle or
    shock originating in emerging economies

UNITED KINGDOM

 

Slowdown amid major uncertainties around the Brexit process

  • The economy has been slowing down since the beginning of 2017 (cumulated rise in GDP of only 0.5% in H1). Rising inflation, uncertainties concerning future access to export markets, slowing investment and real estate dynamics weigh on confidence.
  • The government has provided new indications regarding its Brexit strategy, calling for a two-year transition period. However, negotiations remain difficult due to Theresa May’s weaker position since her June election failure.
  • Shock of uncertainty related to Brexit
  • Foreign deficit is still very
    high

ASIA

 

 

CHINA

Growth stabilisation is sustainable and has an upside

  • The three most important indicators we track are showing signs of improvement: 1). The PPI has stabilised and is now picking up again, indicating continued negative real interest rates , improving corporate earnings and declining NPL ratios; 2). The gap between M1 and M2 growth is widening again indicating that private and public capex is continuing to expand; 3). Residential property investment continues to post double digit growth and there is a widespread lack of property inventory, implying that property will continue to support the overall stabilisation.
  • The longer-than-expected stabilisation of China’s economy (2016 to 2018) is giving rise to a global upturn, which is clearly benefiting global cyclical sectors, commodities and the emerging markets.
  • Burst of credit or property bubbles

 

  • Huge appreciation of the renminbi

 

INDIA

A steady growth driver for Asia in 2017 in spite of demonetisation

 

  • The impacts of demonetisation and the introduction of a new VAT on growth are smaller than the market expected, and we also believe they are temporary.
  • Moderate inflation still leaves room for one rate cut by the end of 2017, following this year’s only cut at the August RBI meeting.
  • Lower-than-expected
    private investment drags
    down productivity
  • Slippage on public
    spending also drags down
    growth

JAPAN

Toward the longest economic expansion since the early 1960s?

  • Growth was very strong in Q2 2017 (+2.5% annualised), well above its potential level (0.8%). The economy is benefiting from the fiscal stimulus, the improvement of the industrial cycle and trade in Asia. Real GDP is likely to grow 1.3% in 2017 although bad weather in the summer will induce temporary stagnation. Business investment will be sanguine reflecting all-time high profits, whereas the tighter labour market is failing to boost wages. The economy should maintain momentum in 2018 (+0.9%) as PM Abe will push his Abenomics
    reform further in education and child care after a snap election in October.
  •  Exposure to China
  • Heightened geopolitical risks with renewed
    tensions with North Korea

 

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2017.10-Market-forecast
ITHURBIDE Philippe , Global Head of Research
BOROWSKI Didier , Head of Macroeconomic Research
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Risk factors, Macroeconomic context and forecasts - October 2017
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