Research Briefing Global
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1 Research Briefing Global Top ten calls for 2017 Trumponomics leads the way Economist Adam Slater Lead Economist +44(0) Our top ten calls for 2017 are, not surprisingly, dominated by the impact of Donald Trump s surprise election victory in November: US reflation to shape the global landscape. The full effect of reflationary policies under the new Trump administration is unlikely to be seen in the real economy until Nevertheless, we do expect US growth to firm in 2017 and US financial market developments to some extent anticipating the likely fiscal policy and growth effects of Trump s policies will have a major impact on the global economic landscape. World GDP growth to improve but only modestly. Although we see world growth rising to 2.6% in 2017 from 2.2% in 2016, many of the factors holding it back remain in place, keeping growth below its long-term average pace next year. World trade growth to remain sluggish. World trade growth is expected to firm to 2.7% next year from 1.3% in But trade growth will remain slow by historic standards reflecting a permanent downshift in the ratio of trade growth/gdp growth. Mixed outcomes in emerging markets. Emerging market growth on the whole will improve in 2017 but performance will differ across countries: Russia and Brazil will exit recession but countries with weak balance of payments positions, high dollar debt and exposure to possible US protectionist actions will be at risk. UK growth to surprise on the upside. We expect UK growth to surprise on the upside in 2017, at 1.5%, as post-brexit vote resilience continues. This will be tempered by lower real income growth as inflation rises. Eurozone to prove surprisingly robust again. We expect Eurozone growth to beat consensus at 1.5% next year, accompanied by higher inflation and higher bond yields. Euro/dollar rate to reach parity by end The widening of interest rate differentials between the US and Eurozone will drive the euro/dollar rate down to parity by end-2017 for the first time since Equities to beat bonds for a second year. Total returns on equities will outstrip those on bonds for the second straight year. Wage growth to make a comeback. With measures of labour market turnover rising we expect wage growth to firm in the advanced economies in Broadly stable renminbi thanks to tighter capital controls. We expect the renminbi to be stable in trade-weighted terms and to depreciate only modestly against the dollar next year, with the Chinese authorities clamping down on capital outflows.
2 The impact of reflationary policies under the Donald Trump administration in the US will not be fully seen in 2017, but these policies and the expectation of them will nevertheless be central to global developments. Many of the factors underpinning the relatively slow growth of the world economy since the global financial crisis remain in place including sluggish investment and world trade, poor productivity growth, demographic drags and the deceleration/transition in China. As a result, our world growth outlook for 2017 remains one of only modest expansion. Nevertheless, the US policy shift will help growth remain relatively robust in the Eurozone and UK next year, with improved wage growth also supporting expansion in the advanced economies. Rising US interest rates next year in expectation of looser US fiscal policy and possible higher inflation will also have important consequences as could uncertainty about the stance of US economic policy in crucial areas such as trade policy. On the currency side we expect the euro to drop towards parity with the dollar and China to tighten capital controls further to prevent significant depreciation. Rising US rates also suggest a differentiated performance among emerging markets in 2017, with countries with weak balance of payments positions or high dollar debt potentially underperforming. Potential protectionist actions by the Trump administration could reinforce this differentiation. On the market side, the shift in US policy will help equities outperform bonds for a second year. 1. World GDP growth to rise but modestly World GDP and trade growth will improve next year to 2.6% from 2.2% in 2016 but remain relatively modest Chart 1 We expect world growth to improve in 2017 but only modestly, to 2.6% from 2.2% in This pace will remain below the 2.8% per year average of the last 30 years or so. The global economy will receive a fillip from an upturn in the US (up to 2.3% from 1.6% growth) and also a better if mixed performance in emerging markets (up to 4.1% from 3.4% growth) where a further modest deceleration of growth in China will be offset by better performances in other large emerging countries. Growth will remain relatively resilient in Europe, including the UK, while slowing from 2016 levels. The impact of more expansionary policies in the US will not be fully seen until 2018 when we expect world growth to reach 2.9%. We expect 2017 to see world GDP growth tick up to 2.6% from 2.2% in 2016, still below the long-term trend. The full impact of expansionary US policies is likely to be seen only in Page 2
3 2. World trade growth to remain sluggish World trade growth will pick up next year but the pace of growth will remain slow World goods trade growth will also improve next year, to 2.7%, helped by stronger import demand in the US and also in Russia, Brazil and India (all drags on world trade growth in 2016). But while next year s forecast growth will be an improvement from the very weak 1.3% estimated for 2016, it will remain far below the long-term average of around 5% per year. Structural factors such as the maturing of international supply chains and a lack of further significant trade liberalisation mean that, in our view, there has been a significant drop in the long-run world trade growth/gdp growth ratio from over 2 in the period to closer to around 1.3. Chart 2 World trade growth is expected to firm to 2.7% next year, up from 1.3% in 2016 but much slower than the historic average. We think the longterm ratio of trade growth/gdp growth has fallen from over 2 to around Higher US growth, but also higher risks Trump s election promises stronger near-term growth but a wide spread of risks as well The election of Donald Trump as US President in November 2016 is likely to lead to a considerable shift in policy in a reflationary direction. Accordingly, our forecast sees US GDP growth rising to 2.3% next year and 2.5% in This will result from substantial personal and corporate tax cuts of US$1tn and increased infrastructure spending of US$200bn. But it will be partly offset by lingering uncertainty, backloaded spending cuts, targeted protectionism and some immigration curbs. Risks around the central forecast are unusually large due to major uncertainties about policy direction: a stronger fiscal stimulus and no protectionism and no immigration curbs could see US growth heading towards 3%, but a trade war and sharp immigration cuts could tip the US into recession. Chart 3 Our US growth forecasts have been revised up following November s election result but risks around the central forecast have also risen given major uncertainties about the policy direction of the Trump administration. Page 3
4 4. Mixed outcomes in emerging markets Emerging market growth will improve in 2017 but performance will be differentiated across countries 2017 will see aggregate emerging market growth improve to 4.1% from 3.4% but performance will differ across countries. We expect Chinese growth to decelerate further, but emerging market growth ex-china will improve helped by Russia and Brazil exiting recession. There will be financial market opportunities in emerging markets, for example in Brazilian debt, but rising US rates and a stronger dollar will be a challenge for some countries, especially those with weak balance of payments positions and high dollar debt. Another risk is potential protectionist actions by the Trump administration. The country most in the firing line is Mexico, where we expect growth to remain slow at just 2.1%. Chart 4 Emerging market growth will rise to 4.1% next year with a particular improvement in countries outside China but performance will be mixed given negative factors such as rising US rates and possible protectionist action by the US. 5. UK growth to surprise on the upside We expect UK growth to surprise on the upside again in 2017, at 1.5% Unlike many forecasters we refrained from predicting a radical slowdown or recession in the UK after the Brexit vote in June 2016 and have thus also avoided having to engage in radical upgrades as the incoming data has proved relatively strong. But the UK economy has proved more resilient than even we expected, with GDP growth at 0.5% in Q and likely to run at a similar pace in Q4. Although we expect some slowdown in 2017 as a rise in inflation eats into consumer real incomes we think consensus forecasts are still too pessimistic. We expect the UK economy to grow by 1.5% next year, down from 2.1% in 2016 but above consensus for growth of just 1.3%. We also expect sterling to be resilient in 2017 despite a modest rise in the US-UK interest rate differential. Chart 5 Our forecasts for UK growth have been consistently above consensus since the June EU referendum and for 2017 our forecast of 1.5% is almost half a point above consensus. Page 4
5 6. Eurozone to prove surprisingly robust again Next year will see solid Eurozone growth, higher inflation and higher bond yields We expect the Eurozone economy to prove surprisingly robust again in Our growth forecast is 1.5%, ahead of consensus for 1.4% and only slightly down from 2016 with growth to be supported by improving labour markets and solid money and credit growth. We do not expect the Eurozone economy to be significantly affected by Brexit-related developments, we think risks from populist political movements are overstated and we think markets are still too fixated on deflationary risks: we expect core inflation to firm to 1.2% from 0.8% in 2016 and German 10-year yields to rise to 0.65% by end-2017, versus around 0.5% expected by markets. Chart 6 We expect the Eurozone recovery to continue at a steady pace next year, with inflation firming and interest rates rising faster next year than the markets expect. 7. Euro/dollar rate to reach parity by end-2017 The euro will slip to parity with the dollar by end-2017, for the first time in 15 years Next year will be another strong year for the dollar. On a trade-weighted basis it will be on average about 4.5% higher than in 2016, on the back of higher US interest rates. This will put the euro under pressure. The /$ exchange rate has been very sensitive to movements in interest rate differentials over the last few years, and we expect 2017 to be a year where these will widen further as the Trump administration embarks on a reflationary programme, pushing up US rates, while Eurozone rates are more static. We expect the 2-year swap rate differential between the US and Eurozone to widen by around 40 basis points, and as a result expect the /$ rate to drop to parity by year end for the first time since Chart 7 With the interest rate differential between the US and Eurozone set to widen significantly next year, we expect the euro to decline to parity with the dollar by year end. Page 5
6 8. Equities to beat bonds for a second year Bond market total returns will be meagre again next year, outstripped by equities As a result of the sharp rise in yields after the US election, 10-year US bonds are set to give meagre total returns over 2016 as a whole, while equities are set to yield double-digit total returns. We expect this pattern of relative performance to continue in US total equity returns will be more modest at around 5% over the year but with US 10-year bond yields forecast to rise a further 30 basis points, total returns from bonds will be very low again. Support for bonds from central bank purchases related to QE programmes will fade from late 2017 as first the ECB, then the UK and Japan cut back and then end QE. Chart 8 We expect equities to outperform bonds in 2017, with support for bonds from central bank purchases fading as QE is tapered from late Wage growth to make a comeback We expect wage growth to firm considerably in the US and UK next year The period of slow wage growth seen over recent years in the advanced economies looks set to come to an end. Some of the factors that have held wage growth back such as changes in the composition of the workforce (especially strong entry into the workforce of low-waged workers) are starting to fade and measures of labour market turnover like quit rates have risen notably in the US, UK and Germany (but less so in Japan) pointing to upward pressure on wages. We forecast wage growth will accelerate in the US from 2.5% in 2016 to 2.8% in 2017 and in the UK from 2.4% to 2.9%. Chart 9 Measures of labour market turnover have been rising in the US, UK and Germany signaling upward pressure on wages Page 6
7 10. Broadly stable Chinese renminbi thanks to tighter capital controls We expect the Chinese authorities to clamp down on capital outflows to preserve currency stability Chart 10 Our estimates suggest capital outflows from China have been creeping up again in recent months and outflow pressures are likely to persist, if not strengthen, in 2017 as US interest rates rise. In response, instead of letting the CNY depreciate significantly, the authorities have been moving to curb outflow by a variety of means including screening and restricting outbound investment and tighter enforcement of existing regulations. We expect this to continue in 2017, with additional controls also introduced if necessary. As a result we expect the CNY to be broadly stable on a trade-weighted basis next year after depreciating about 5% in 2016 and to weaken only modestly against the US$. China s balance of payments position and currency is likely to come under further pressure thanks to a strong dollar and higher US interest rates, requiring the Chinese authorities to further clamp down on capital outflows. Wildcards Trump sticks to his guns President Trump follows through on his campaign rhetoric in areas like protectionism and immigration, pushing the US towards our downside Trump growth scenario, and damaging world growth also. Fed more hawkish than expected inflation rises faster than expected in the US and globally leading the Fed to a hawkish stance that sees four rate hikes in 2017 instead of two as in our baseline. Globalisation goes into retreat a protectionist US Trump administration plus a rise in populist politics in Europe (e.g. France and Italy) combine to disrupt the world trading system. Further drop in commodity prices supply overhangs start to press down key commodity prices again, damaging prospects for some key emerging markets. Turkey slips into authoritarianism the drift towards authoritarian rule in Turkey accelerates, damaging Turkey s relations with the West and adding to regional tensions. Global imbalances deteriorate sharply expansionary policies in the US lead to a soaring dollar and a sharp rise in the US current account deficit, creating FX market pressures in emerging markets and adding to protectionist risks. China tightens exchange controls severely strong capital outflows require the Chinese authorities to introduce much stricter capital controls in a significant blow to the process of market-based reform. Page 7
8 How we did last year Here are last year s top ten predictions, with a short assessment of each one: World growth steady but sluggish. Largely accurate: we expected world growth at 2.6% in 2016, with the outcome likely to be 2.2%. This outcome will be well below the long-term average and the consensus as of end-2015 (both around 2.8%). Only two Fed hikes in Mixed; we rightly argued that the Fed would be very cautious in 2016 due to sluggish growth and jittery markets, but there was only one hike in US and UK to lead G7 growth above 2%. Inaccurate. G7 growth looks set to come in at 1.4% for 2016, slower than in 2015 with both the UK and US growing more slowly than we expected (at 2.1% and 1.6% respectively). Resilient Eurozone led by Germany. Accurate. We expected Eurozone GDP growth at 1.8% for 2016 and our current forecast is close to this at 1.6%. Within this, Germany has indeed been one of the stronger performing countries with growth expected at 1.8% this year. A bad year for US equities. Inaccurate. US stock were indeed weak in H1 2016, as we expected, but rallied in H2 especially after the US election and look likely to end 2016 about 6% higher than at end-2015 (our forecast last year was for a flat outcome). Fifth straight year of dollar strength. Accurate. The trade-weighted dollar is now expected to end the year 4% higher than at end-2015, very close to the forecast we had at the end of last year. Another subdued (or worse) year for emerging markets. Accurate. We expect aggregate growth in emerging markets to be 3.4% in 2016, marginally lower than in 2015 and close to our forecast of end Slower growth in China, but no hard landing. Accurate. We expected only a moderate slowdown in Chinese growth in 2016 and this looks likely to be correct with our forecast for growth this year at 6.7% versus 6.9% in Some upside surprises on inflation. Mixed. We expected headline and core inflation in the US at around 1% and 2% respectively this year, and the likely outturns will be close to this. However, we were too pessimistic in expecting German inflation to head towards 2% by end Among EMs, we expected inflation to remain elevated and above consensus in a number of key countries: this proved accurate for Brazil, Turkey, Russia and South Africa but less so for Malaysia and Mexico. Trouble on the risk frontier. Mixed. We expected corporate default rates to rise in 2016, both in advanced and emerging markets and this has proven to be correct. We also expected a formal default in Venezuela and rising yields in Ukraine and for Brazil to lose its investment grade status. These calls were all largely accurate with Venezuela s PDVSA executing a distressed exchange in October and missing a coupon payment in November, Ukrainian Eurobond yields rising to 9.5% and Brazil rated below investment grade by all major agencies. Wild cards we correctly suggested that the UK Brexit vote was far from being a foregone conclusion. Page 8
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