8 May 2018
Outlook remains positive despite trade war
The global economy continues to improve, despite increased financial market volatility and downside risks from heightened global trade tensions
The global economy continues to improve, despite increased financial market volatility and downside risks from heightened global trade tensions. Overall, the global expansion looks set to strengthen further in 2018, with private investment spending and global trade volumes now showing more obvious signs of recovery (Chart 1). Added to this, economic momentum is likely to be reinforced by new fiscal stimulus in the US and Germany, which will further boost short-term growth prospects.
In this environment, the main global macro risk remains the possibility that higher global interest rates may expose asset price vulnerabilities. The possibility of an escalated trade war between the United States and China is another risk with the potential to derail the global economic recovery (although we think this unlikely).
In the US, the outlook for growth remains positive. Unemployment is now at 4.1%, the lowest level in nearly two decades. Elevated consumer confidence continues to support consumer spending and business investment has also improved markedly over the past year, with business surveys pointing to further gains ahead. Policy settings also remain expansionary, with additional fiscal stimulus and continued accommodative financial conditions continuing to support growth. Meanwhile, inflationary pressures remain contained, with inflation running slightly below the Federal Reserve’s 2% target. In this environment, we expect US interest rates to continue to steadily “normalise”; the FOMC raised the federal funds target rate by 0.25pts to 1.50‒1.75% in March and we expect a further three rate hikes this year.
Growth in the UK continues to lag the rest of Europe, with most indicators pointing to a continuation of below-trend growth in 2018. Real GDP growth slowed to 1.7% p.a. in 2017, the third consecutive year of slowing annual growth. The outlook for 2018 and 2019 are for a further moderation in growth to 1.4% in 2018 and 1.5% in 2019. However, the balance of risks has become more favourable in recent months, thanks to the in-principle agreement with the EU on a Brexit transitional period (deferring exit to December 2020), which markets have interpreted as a sign of reduced risk of a disorderly Brexit. There are also positive signs that the UK labour market has continued to record strong gains, with the unemployment rate now just 4.3% (the lowest since 1975).
In China, the outlook for growth remains positive. Real GDP is forecast to moderate steadily to 6.7% in 2018 and 6.4% in 2019. The steady slowdown reflects the government‘s continued efforts to reduce leverage and excess capacity in the Chinese economy. Encouragingly, there are a number of positive signs that China is succeeding in rebalancing its economic growth away from its excessive reliance on inefficient, debt-fuelled investment, with domestic consumption now becoming a more important driver of demand.
The improved global outlook has also been positive for a number of emerging markets, particularly commodity exporters like Brazil. Latin America is forecast to enjoy stronger economic conditions in 2018, with faster growth and an improved business environment. However, the region still significant political headwinds. In addition, Brazil also remains highly exposed global factors including commodity prices, US protectionism, and any disruption to Chinese or US economic growth.
In Europe, the outlook for growth also remains sanguine. EU real GDP grew by a robust 2.7% y-o-y in Q4 2017 and the latest survey data point to continued strong growth in 2018. The composite PMI (a good leading indicator of euro area growth) remains above its long-term average and close to a 12-year high. The ongoing expansion has led to strong employment gains, with almost 8 million jobs created in the euro area since the depths of 2013 Eurozone crisis. As a result, the EU’s unemployment rate (7.3% in January) is now back to its lowest level since December 2008. The main European uncertainty remains in Italy. Italian politics continues to be in a mess; the first round of talks between the Italian President and party leaders was inconclusive, although there is still the possibility of a deal between the populist 5SM and far-right euro-sceptic League.
Global housing cycles are becoming more synchronised: The sustained global economic recovery, coupled with historic low borrowing costs, has provided a major boost to house prices across many cities and countries (Chart 2). However, recent IMF research highlights, this may have increased the potential downside risks facing global residential markets.
The IMF research highlights that global housing markets have been steadily becoming increasingly synchronised across major global cities in the current cycle, with house prices in many markets now showing a growing tendency to move in the same direction at the same time. A possible explanation for this trend is continued integration of global financial markets and greater cross-border capital flows by global investors (particularly Chinese investors) in search for yield or safe assets, which has accelerated foreign demand for housing in many major cities.
This suggests that residential markets are starting to behave more like the other financial assets. As a result, housing markets in one country are now more sensitive to potential swings in another. A more synchronised global housing cycle has clear implications for investors’ diversification strategies and suggests that there is greater downside risk from any sudden slowdown in global economic growth, as local housing market dynamics are now more vulnerable to unexpected foreign shocks.