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Risk factors, Macroeconomic context and forecasts - February 2018

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

Flag-UK
February 2018

Flag-FR
Février 2018

 

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

Risk factors 1
Risk factors 2

Banner-macroeconomic-context

 

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

Central scenario (75% probability): continued expansion of global activity.

  • Global resynchronisation: global growth will remain dynamic in 2018 and 2019. The advanced economies (with the notable exception of the UK) will continue to experience above potential growth. The major emerging economies will also continue to grow at a sustained pace. The ongoing rebalancing in China is progressing quietly – such that the slowdown appears to be under control. The recovery in most economies is being driven by domestic demand, and we note a recovery in investment in many regions (US, Europe, Japan, Asia). The resynchronisation of the global cycle generates “multiplier effects” – via trade – that sustain the recovery on a global scale and make it more robust.
  • World trade: world trade recovered markedly in 2017 (+5% over one year). It continues to be stimulated by the resynchronisation of the global cycle and investment in capital goods. However, this effect is expected to gradually wane this year: we anticipate a stabilisation of the world-trade to world-GDP ratio in the future.
  • United States: Growth is solidly established as the year begins. Most of the surveys continue to point to above potential growth. Domestic demand was quite strong in Q4 and seems to accelerate further in Q1 (we revised up our GDP forecast for 2.6 to 2.7% in 2018). . The very accommodative monetary and financial conditions (despite the expected hike in the fed funds rate) and the fiscal stimulus voted through in December significantly reduce the risk of a recession in 2018-19. We note that wages have started to accelerate: that was inevitable - at some point- with an economy that operates at or close to full employment.
  • Eurozone: the recovery is widespread, with a pick-up in investment in most countries. Growth is mainly being driven by domestic demand, but is also benefitting from a very robust global backdrop. Political risk has faded considerably, becoming more local (the status of Catalonia in Spain is primarily a domestic issue, while in Italy, the anti-euro parties have no chance of winning an absolute majority in the elections scheduled for 4 March, see the article on this topic in the current edition of the cross assets). The reduction in asset purchases by the ECB is likely to be accompanied by a rise in both long-term interest rates in the core countries and the Euro. Hence the slight decline in growth expected in 2019. Nonetheless, with credit conditions still highly accommodative, growth should remain significantly above potential in 2018 and 2019.
  • UK: in December, EU countries followed the Commission’s recommendations according to which “adequate progress” had been made to open trade negotiations between the United Kingdom and the EU. Moreover, EU countries are now accepting the principle of a time-limited transition period up to the end of 2020, during which the UK would retain de facto access to the single market. This being the case, the threat of a hard Brexit is no longer imminent, at least in 2019. Admittedly, uncertainty will continue to weigh down the British economy, but more diffusely. We expect below potential growth but without any abrupt downturn.
  • China: growth is more robust than expected. The reduction in overcapacity has reduced the downside risks. The economy’s growth drivers are now more diversified. Debt remains essentially domestic and manageable. We expect the gradual deceleration of growth to continue and a slow rebalancing (less growth, less debt). The transition looks to be under control. However, vigilance should still be exercised.
  • Inflation:  core inflation, which is excessively low at this stage in the cycle (especially in advanced economies), is expected to recover gradually in 2018. That said, the slowdown in inflation over recent years is primarily structural (tied to supply factors), while the cyclical component of inflation has weakened (flattening of the Phillips curve). While the pick-up in core inflation promises to be modest, the likelihood of an “inflation surprise” is nonetheless increasing as surplus capacities disappear around the world (we estimate that the global output gap will close in 2018 for the first time since the great financial crisis). The risk is easier to spot in the US(we expect wages to continue to accelerate), given how close the economy is to full employment and how certain temporary factors (such as the drop in mobile phone service prices in the spring of 2017) have disappeared, which will automatically push inflation upward at the end of Q1 2018 (base effect).
  • Oil prices: we expect (Brent) oil prices to ease back slightly from their current level. At $68 (Brent), the risk now looks lopsided to us (more risk of prices falling than soaring). In fact, if prices stay much above the breakeven point for US oil deposits, US production will end up increasing sharply..
  • Fiscal policies:  Two countries are in the spotlight this year: the United States and Germany. In the US, the income and corporate tax cuts (among other measures) approved by Congress in December are effective, which will  give growth a shot in the arm over the next 18 months. In Germany, some tax cuts are likely this year. On average, fiscal policies will be neutral, or even slightly expansionist, in the large advanced countries.
  • In 2018, the central banks will continue to whittle down their accommodative monetary policy,  which is excessive in view of the current recovery. The Fed will continue to raise its key interest rates (we anticipate three 25bp hikes in 2018) and reduce its balance sheet at the announced pace (with a gradual non-replacement of papers reaching maturity); meanwhile, the ECB could put an end to its QE programme as soon as Q4 2018, which would potentially open the door to the first increase in its deposit rate in early 2019. That said, monetary policies will remain accommodative overall, because even if some cyclical inflation does materialise later in the year, inflation will stay well below its historic average for the structural reasons we mentioned (flattening of the Phillips curve, continued downward pressure on the prices of many goods and services).

Pessimistic risk scenario (10% probability): marked economic slowdown due to incorrect economic policy (excessively quick monetary policy normalisation or protectionist measures) or a geopolitical crisis

 

  • The pro-cyclical fiscal policy forces the Fed to accelerate the monetary policy normalisation process.
  • Protectionist measures (US) as mid-term elections draw nearer.
  •  International crisis stemming from acute aggravation of current geopolitical tensions (Middle East, Korea).

Consequences:

  • An abrupt re-evaluation of risks on the fixed income markets, with a global decompression of spreads (govies and credit, on the developed and emerging markets alike). Decline in market liquidity.
  • Risk of disorderly deleveraging.
  • With the resulting financial turbulence, the cycle is abruptly interrupted and inflation cannot stabilise.
  • Central banks are forced to turn to unconventional tools once again (expanding their balance sheets).

Optimistic risk scenario (15% probability): continued sharp pick-up in global growth in 2018

 

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

  • Sharp pick-up driven by business investment, global trade, and synchronisation of the overall cycle.
  • In a very promising environment, the pro-cyclical US tax policy generates a stronger than expected pick-up in domestic growth. Continued acceleration cycle in the eurozone, stabilisation in China, confirmation of the trend in Japan, etc.
  • With inflation remaining extremely low, central banks would continue to maintain easy monetary conditions, at least at first, enabling a “mini-boom.”

Consequences:

  • A marked pick-up in global growth for the second consecutive year would increase inflation expectations, forcing the central banks to consider normalising their monetary policy much more quickly.
  • Rise in real key interest rates (in the US especially).
  • Given the resulting financial turbulence, the mini-boom of the first half would not last long. There would be a greater risk of a boom/bust (i.e. the bust after the boom).

 

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AMERICAS

 

RISK FACTORS

UNITED STATES

  • Government Shutdown briefly occurred, but it should not impact Q1 economic growth. We expect the US to grow well above potential in 2018. Coincident indicators and survey remain upbeat and the Tax Cuts and Jobs Act should boost consumer spending and Capex.
  • The labour market keeps improving, with also tentative yet mixed, signs of pickup in labour compensation. In this framework, inflation should revert gradually to target, with
    some upside risks and temporary overshoot.
  • The Fed should therefore be able to deliver three hikes in 2018.
  • Debt Ceiling: Treasury’s
    extraordinary measures
    extend borrowing till late
    March 18
  • Protectionist risk, NAFTA
    negotiations
  • Upside risks to inflation:
    economy close to full
    employment

 BRAZIL

Recovery on track and elections noise growing

  • Brazilian economic growth recovery is holding well. Households expenditure finds support in Real Wages significant increase and Credit rebounding. Industrial Production in Capital Goods is picking up and it’s coherent with a surge in Capex and Credit to Private Corporate looks like having bottomed out. Inflation is still contained thanks to Food Prices, while Transport and Housing components are peaking up. With regard to next general elections, consensus is growing about the impossibility of Lula to run after recent corruption sentence (now in appeal).
  • Improving economic
    conditions with
    unsustainable fiscal path
  • Pension reform unlikely
  • Rise in political risks
    with the approaching
    presidential elections

EUROPE

 

 

EUROZONE

 

The recovery continues with a lot of remaining potential

  • The series of upside surprises continue to pile up. Q4 GDP growth was +0.6% and business climate indicators were very strong in January. The economy is supported by many factors (recovery in capex, end of austerity policies, declining political risk, strong growth in the USA and Asia). At this stage, the rise in the Euro is not enough to threaten the recovery, although a rapid additional rise could become a serious headwind.
  • Residual political uncertainties in large countries (search for a government coalition in Germany, regional crisis in Catalonia, Italian general elections) do not carry systemic risk.
  • Rise in the Euro
  • Political risk (rise in antiestablishment
    parties, notably in Italy)
  • External risks

UNITED KINGDOM

 

Slowdown amid major uncertainties around the Brexit process

  • The economy has been slowing down since the beginning of 2017. Uncertainties concerning the Brexit process is detrimental to confidence. Sterling-induced inflation should be temporary. Despite the very low unemployment rate, wages are not picking up.
  • The negotiation of a transition period should limit the immediate Brexit shock. However visibility on the future framework of trade relations with the EU is nil and the internal political situation remains tense (no Parliament majority for the Conservative Party, deep divisions within this party regarding Brexit).

 

  • Strained negociations ahead on trade
  • Weak government
    (no majority without the
    DUP)
  • Foreign deficit is still very high

ASIA

 

 

CHINA

Q4 data show resilience of the economy.

  • Official GDP growth steadied in Q4, better than consensus. Nominal growth held up at double digits, supported by continued supply cut efforts. Part of industry and construction slowed, linked to anti-pollution measures, but offset by stronger services, with exports and high-end manufacturing remaining strong. Property sector looks more resilient than most concerned. 
  • Recent strength in RMB reflected, more than just weak dollar, improvements of expectations, particularly locals, which implies risks skewed towards upside for further moderate appreciation of RMB.
  • China’s top officials sent strong messages of further reforms and opening-up in World Economic Forum, while worth to monitor Trump’s trade policy following recent measures.
  • Policy mistakes in
    managing structural
    transition
  • Geopolitical noises
    regarding North Korea
    and with US

 

INDIA

Growth deceleration in Q4 2017 (CY)

  • India recovery in Q4 2017 (CY) has been less brilliant than anticipated. Aside an evident base effect kicking in correspondence of demonetization in November 2016, Private Investments remain quite weak in terms of projects and implementation. We therefore downward revised our GDP expectations for CY 2017 at 6.9% from 7.2%. Budget Law for FY19 has confirmed a pause on the fiscal consolidation path trying to favour penalized sectors of the economy like Rural India (farmers). Inflation has being surprising to the upside and subsidies policies embedded in the budget add further upside risk to inflation. RBI is expected on hold for a while.
  • Q4 2017 (CY) recovery less brilliant than anticipated. GDP expectations revised down
  • Inflation is increasing faster than expected. RBI on hold.
  • Fiscal slippage likely

JAPAN

Toward the longest economic expansion since the early 1960s

  • Expansion continues driven by investment (which benefits from very strong corporate profits) and exports (driven by the strength of global trade). Corporate sentiment breached an 11-year high for large companies and a 26-year high for small firms (Tankan). The unemployment rate is at its lowest in 24 years and the “Job offers to applicant ratio” is at its highest since 1974. More companies are confident of a higher sales price. Capital spending plan for this year remain much stronger than historical average. The government encourages companies to raise wage and salaries by more than 3% in the next spring negotiation.

 

  • Geopolitical risks (tensions with North Korea)

 

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Risk factors 3
BOROWSKI Didier , Head of Macroeconomic Research
ITHURBIDE Philippe , Global Head of Research
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Risk factors, Macroeconomic context and forecasts - February 2018
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