Forces driving the world economy and global macro markets

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1 The Goldman Sachs Group, Inc. Forces driving the world economy and global macro markets The global panorama November 2017 Huw Pill Chief European Economist Goldman Sachs International Andrew Benito Goldman Sachs International Alain Durré Goldman Sachs Paris Inc et Cie +33-(1) Lasse Holboell Nielsen Goldman Sachs International Adrian Paul Goldman Sachs International Pierre Vernet Goldman Sachs International Dylan Smith Goldman Sachs International Goldman Sachs does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. For Reg AC certification and other important disclosures, see the Disclosure Appendix, or go to Analysts employed by non-us affiliates are not registered/qualified as research analysts with FINRA in the U.S..

2 Forces driving the world economy and global macro markets Cyclical Reflation / recovery Monetary policy normalisation Structural / secular Globalisation Technological change Demographics Productivity Populism 2

3 Growth in the advanced economies is (finally) beating our expectations Outturns are exceeding our earlier forecasts for G-7 growth G7 Real GDP, %change yoy, quarterly which we expect to reach ~2%pa in G7 Inflation, %change yoy, quarterly 3 % GS Cons. GS Cons. GS 2.5 G US UK Japan Germany France GS Quarterly Forecasts Current Forecast Actual Italy Canada Source: Goldman Sachs 3

4 and recent revisions to consensus growth forecasts have been positive rather than negative Historically, consensus GDP forecasts have been too optimistic, although perhaps that is changing GS G7 Real GDP, forecast, % % But in 2016, China s impulse was better than expected China impulse to Euro area growth, pp pp Difference between actual and expected impulse Actual impulse to Euro area growth Expected impulse to Euro area growth, as of the beginning of Q3 2015Q4 2016Q1 2016Q2 2016Q3 2016Q4 2017Q1 Source: Goldman Sachs Source: : Goldman Sachs 4

5 Global growth is looking more resilient, even as China is poised to slow somewhat Real GDP Growth Percent Change yoy (f) 2018 (f) GS Cons* GS Cons* US Japan Euro Area Germany France Italy Spain UK China India** Russia Brazil Developed Markets Emerging Markets World * Bloomberg consensus forecasts as of September. ** Fiscal year basis, 2016 is India FY17 (Q Q1 2017). Source: Goldman Sachs 5

6 with turn in manufacturing cycle supporting growth in world trade after hiatus Source: Goldman Sachs 6

7 No matter how you measure it, global trade has begun to recover % yoy growth in the 3m average of the displayed measure 30% 20% High and sustained global trade growth during the "trade boom" of the 2000s......and, over the past year, an encouraging rebound 10% 0% -10% -20% -30% -40% value: USD value index: TWI value index: local currency volume index, 'direct': seafreight volume index, 'direct': airfreight volume index, 'indirect'...was followed by years of post-crisis stagnation... '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 '17 Source: Goldman Sachs, Haver Analytics, CPB World Trade Monitor. 7

8 Jan-'14 Feb-'14 Mar-'14 Apr-'14 May-'14 Jun-'14 Jul-'14 Aug-'14 Sep-'14 Oct-'14 Nov-'14 Dec-'14 Jan-'15 Feb-'15 Mar-'15 Apr-'15 May-'15 Jun-'15 Jul-'15 Aug-'15 Sep-'15 Oct-'15 Nov-'15 Dec-'15 Jan-'16 Feb-'16 Mar-'16 Apr-'16 May-'16 Jun-'16 Jul-'16 Aug-'16 Sep-'16 Oct-'16 Nov-'16 Dec-'16 Jan-'17 Feb-'17 Mar-'17 Apr-'17 May-'17 Jun-'17 Jul-'17 Global trade in 2017: more volatile, still strong % yoy growth in the displayed measure 14% 12% 10% value index: TWI value index: local currency volume index, 'direct': seafreight volume index, 'direct': airfreight volume index, 'indirect' average: value, 'direct' volume and 'indirect' volume measures 8% 6% 4% 2% 0% -2% -4% -6% Source: Goldman Sachs, Haver Analytics, CPB World Trade Monitor. 8

9 Global trade in 2017: more volatile, still strong bilateral trade flows relative to global total Source: Goldman Sachs, Haver Analytics 9

10 Global trade in 2017: more volatile, still strong bilateral trade flows relative to global total Source: Goldman Sachs, Haver Analytics 10

11 US and Chinese growth matter most for the Euro area economy total impact of 1pp decline in growth on Euro area growth Source: Goldman Sachs 11

12 US and Chinese growth matter most for the Euro area economy total impact of 1 standard deviation decline in growth on Euro area growth Source: Goldman Sachs 12

13 We also see the first signs of a modest revival of inflation, but price pressure is (very) moderate Inflation remains stubbornly below the 2% target of most G7 Central Banks G7 Inflation, %change yoy, quarterly 3 a trend we continue to forecast globally into 2019 G7 Inflation, %change yoy % GS Cons. GS Cons. GS 2.5 G US UK Japan Germany GS Quarterly Forecasts Current Forecast Actual France Italy Canada Source: Goldman Sachs 13

14 and the German Phillips curve has become flatter over time A lower equilibrium rate of unemployment U* has shifted the German Phillips curve over time German Phillips curves (the trade-off between labour market slack and inflation) and U* through time German 'macro' inflation* (π t ), year-on-year % Phillips Curve assumed in 2017Q1 forecast round German Phillips curves: Now SPACE Migration towards new Phillips curve Equilibrium unemployment rate, U* March 'Real-time' Phillips Curve (Euro area debt crisis) (Germany in recession) German unemployment rate (u t ), % SA Source: Goldman Sachs, Eurostat, Note: * Macro inflation controls for large relative price changes as well as changes in VAT and excludes highly volatile energy and food prices; Core inflation simply excludes energy food alcohol and tobacco prices from the headline measure 14

15 leading to significant missing German wage growth German wage growth has remained muted despite large falls in unemployment %yoy, dynamic out of sample forecast Source: Goldman Sachs 15

16 Central banks have faced constraint of lower bound on policy rates Estimated real time Taylor rule, % % Eonia (post ECB monetary policy meeting) Model w. real time gap, core infl, pmi & unr (sample Jan Nov 2011) Model w. real time gap, core infl, pmi, unr & Staff CPI 1yr fcast (sample Jan Nov 2011) 4 3 Out-of-sample forecast ECB meeting Jun Source: Goldman Sachs, ECB 16

17 leading to introduction of various supportive balance sheet policies such as QE Although the US may be leading the way to a reduction in balance sheet size and the ECB will reduce APP in the coming year Central Bank balance sheet as a percentage of GDP, % % Start of ECB % US Federal Reserve 'Whatever sovereign Bank of England it takes' asset European Central Bank purchases Bank of Japan Failure of Lehman Source: Goldman Sachs, US Federal Reserve Board, Bank of England, Eurostat, Bank of Japan, Ministry of Finance Japan 0 17

18 but also keeping rates lower for longer, in part via offering forward guidance Estimated real time Taylor rule, % % Eonia (post ECB monetary policy meeting) Model w. real time gap, core infl, pmi & unr (sample Jan Nov 2011) Model w. real time gap, core infl, pmi, unr & Staff CPI 1yr fcast (sample Jan Nov 2011) 4 3 Out-of-sample forecast ECB meeting Jun Source: Goldman Sachs, ECB 18

19 Central banks have been keeping their key rates low, but US Fed has started to normalise The US appears to be paving the way to policy normalization and we expect the other central banks to follow key Central Bank policy rates, % % % BoE: Official Bank Rate GS Forecast US: Fed Funds Target Rate ECB: Main Refinancing Rate Source: Goldman Sachs, Bank of England, European Central Bank, US Federal Reserve Board 19

20 Core inflation gap (%) as it approaches (dual) mandate, whereas others remain more distant from objectives 0.5 Deviation from Central Banks' Goals Q Q Q Q US Q Q Euro Area Japan Employment gap (%) Source: Goldman Sachs, Bank of England, European Central Bank, US Federal Reserve Board 20

21 Forward inflation assessments have risen from their mid-2016 lows, but not back to pre-crisis levels Market pricing has consistently re-evaluated expected inflation downwards Implied HICP inflation curves and GD forecast, %yoy 5.0 % Indexed swap rates implied inflation curves for the Euro area Latest swap based inflation curve (May) % 5.0 GS Forecast (Headline HICP inflation ex-tobacco) 4.0 Realized annual Euro area HICP inflation excluding tobacco (unrevised) Forward inflation curve as of August 2014 (Jackson Hole, where Mr Draghi signals ECB QE) Forward inflation curve low - July Source: Goldman Sachs, Bloomberg

22 S&P 500 European HY US HY MSCI World SXXP MSCI EM Topix US IG European IG Germ. Bond Gold US Bond Japan Bond US Nominal GDP EU Nominal GDP US wages European wages US CPI US House Price European CPI EA House Price Commodity By design, asset prices are at elevated (and therefore perhaps vulnerable) levels Total return performance in local currency since January % 250% Financial asset prices Real economy prices 200% 150% 100% 50% 0% -50% -100% Source: Datastream, Haver Analytics, Goldman Sachs 22

23 Compared with the aftermath of the Great Depression, inflation performance has not been bad The deflationary traps of the 1930s are conspicuous in their absence from the post-2007/08 experience Cumulative change in the level of consumer prices during recovery A decade on from the nadir of the 2007/08 financial crisis, the recovery in output has been anaemic Cumulative change in real GDP during recovery % change, t-1 to t+8 Second quaritle Third quartile Mean Bottom decile Top decile 2% annual inflation % change, t-1 to t+8 Third quartile Second quartile Mean Bottom decile Top decile /08 crises 1930s crises Other crises /08 crises 1930s crises Other crises Source: Goldman Sachs Source: Goldman Sachs 23

24 but policy mix has been different (easier monetary policy, less expansionary fiscal policy) Government spending grew relatively more after the crisis of the 1930s Nominal government spending Quantitative easing after 2008 drove long rates lower for longer than in the 1930s Nominal long-term interest rates Source: Goldman Sachs Source: Goldman Sachs 24

25 with significant distributional implications that have political consequences Income inequality evolved similarly in the aftermath of crises in and the 1930s Income accruing to top 1% of earners but inequalities in wealth have risen significantly since the crisis by contrast with the 1930s Wealth held by 1% wealthiest Source: Goldman Sachs Source: Goldman Sachs 25

26 Drivers of Brexit more social than economic It is not (only) cyclical economic factors that have driven the recent rise in (European) populism Source: Goldman Sachs 26

27 with sharp urban / rural divide in France Votes for Le Pen in 2012 first round presidential election Cities do not support Le Pen Source: Goldman Sachs 27

28 Despite rapid technological change, productivity (in the UK) has stagnated over the past decade index Output per hour in the UK Source: ONS, Goldman Sachs 28

29 an even starker break when viewed from a long-run perspective back to the mid 19 th century Source: ONS, Goldman Sachs 29

30 Disclosure Appendix October 27,

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