Annual economic outlook for 2018

Transcription

1 Global Economic and Market Insights Annual economic outlook for 2018 John Greenwood Chief Economist, Invesco Ltd. Summary Prospects for a record long business cycle expansion According to the National Bureau of Economic Research (NBER), the longest business cycle expansion in recorded US economic history was the 10-year period from March 1991 to March Since the current US expansion dates from the trough in June 2009, it has already been underway for just over 100 months. I am confident that the previous record of 120 months will be exceeded. Global economic activity has strengthened during 2017, with good performance in the US during the second and third quarters and a steadily improving performance in continental Europe throughout the year. In China, however, economic momentum has been weakening, led by a mild slowdown in the property sector, but in most of the other emerging economies momentum is improving. Economies operating at close to full capacity Looking ahead to 2018, I expect economic activity to remain buoyant, but in contrast with most economists, I do not automatically assume that this will mean higher inflation. Unemployment has fallen to 4.1% in the US, 4.3% in the UK and 3.7% in Germany, while in Japan the ratio of job offers-to-applicants (another measure of labor force tightness) has risen to 1.55, its highest level since However, participation rates in several countries are low and many part-time workers would like to be working either longer hours or full time. Inflation still subdued and not yet a threat to expansion For several years, consumer price inflation (CPI) and core inflation have been running below the target rate of 2% in most developed economies. Against a backdrop of unconventional monetary easing via quantitative easing (QE), exceptionally low levels of interest rates and continuing budget deficits, low inflation has been something of a puzzle to many economists and central bankers - notably including Janet Yellen (who confessed to not understanding why inflation remained so low). The correct answer has little to do with the Phillips curve or output gaps, but underlying monetary growth, which has remained low in most major developed economies. As long as this remains the case and inflation and inflation expectations also remain low, there is no reason to expect a monetary policy tightening of the kind that would threaten to end the business cycle expansion. Normalization of monetary policies does not spell tightening Among the developed economies, only a few central banks have started to normalize monetary policy. The US Federal Reserve has been raising interest rates slowly and gradually since December 2015, and has recently embarked on a policy of balance sheet shrinkage. The Bank of Canada has raised interest rates (twice) and the Bank of England also raised rates in November. These policy moves should be seen not as deliberate tightening in the sense of attempting to lower the rates of growth of money and credit, but merely as an effort to restore relatively normal interest rate levels. In fact, a key feature of the current expansion has been the sustained, moderate growth rate of money and credit across most Organisation for Economic Cooperation and Development (OECD) member economies.

2 Figure 1 The Phillips curve is not working in advanced economies Actual data, Employment cost index (% YOY) Typical Phillips curve Unemployment rate (%) Source: Macrobond and Invesco calculations as of Dec. 8, High valuations need not be a threat to economic expansion For much of 2017, investors were fearful of a major correction in bond and equity markets, but no obvious buying opportunity presented itself. Although bonds suffered a setback in late 2016 and early 2017, and high yield bonds suffered a brief sell-off in November, the US and other major stock markets have enjoyed a year of steady gains with extremely low volatility. The result is that equity and real estate valuations are now at elevated levels. However, high valuations alone do not produce market setbacks. One reason is that the current level of asset prices is not based on high leverage (as it was in 2008), but rather extremely low interest rates. As long as central banks raise rates very slowly and cautiously and the business cycle expansion remains intact, financial markets can continue to discount continued earnings growth for several years ahead estimate 2018 consensus forecast (Invesco forecast) Consensus economics Real GDP (%) CPI inflation (%) Real GDP (%) CPI inflation (%) US (2.4) 2.1 (1.8) Eurozone (2.2) 1.4 (1.5) UK (1.4) 2.6 (2.4) Japan (1.2) 0.8 (0.5) Australia (2.7) 2.2 (2.0) Canada (2.2) 1.9 (1.5) China (6.6) 2.2 (1.0) India (6.4) 4.6 (2.5) Source: Consensus Economics, Survey Date: Dec. 4, Annual economic outlook for 2018

3 United States The 23% rally in the S&P 500 Index from early November 2016 to the end of November 2017, though boosted initially by the election of President Donald Trump and the expectations generated by his agenda, has not owed much at all to the new administration in Washington. The real driver, in my view, has been the gradual upswing of the business cycle expansion. This is in line with historical experience which teaches that the broad movements of asset prices bonds, equities and real estate prices are dominated by business cycle trends. The outlook for the coming year, both in US financial markets and in the economy, therefore depends heavily on how long the current business cycle expansion can be extended. The longest business cycle expansion in recorded US financial history was the 10 years from March 1991 to March 2001 under Alan Greenspan at the US Federal Reserve (Fed). Since the latest NBERdesignated trough in June 2009, the current expansion has been underway for eight and a half years, but I believe it will become the longest US expansion ever recorded. The reason is that its early years ( ) were spent repairing balance sheets by deleveraging and recapitalizing this resulted in sub-par growth. Since then, growth has improved, but the economy is by no means overheated either in terms of wages or inflation. Business cycles end not by old age but predominantly through tightening actions by a central bank such as raising short-term interest rates, inverting the yield curve or by squeezing money and credit growth. Since the Fed currently has no need to undertake such drastic policy measures, I remain confident that the present expansion will continue through 2018 and into During the election campaign Trump and some of his associates claimed they could accelerate the economy to a 3.5% to 4.0% real gross domestic product (GDP) growth rate, but in my view that was always an unreasonable expectation. Annual growth in the 2.0% to 2.5% range looks more likely, both for 2018 and as a longer-term trend, even after Trump s proposed income and corporate tax cuts. The interesting question, puzzling to many central bankers as well as academic and investment bank economists, is why inflation has remained so subdued for so long. After all, labor markets have tightened and the output gap has been narrowing, implying in the view of many economists there is little spare capacity available to absorb stronger spending. Based on this Phillips curve analysis, inflation should now be rising more rapidly. Yet inflation, as measured by the core personal consumption expenditure (PCE) deflator, has remained persistently below the Fed s 2% target for 105 of the 109 monthly core PCE inflation readings since October Moreover, three out of four widely followed measures of underlying inflation (the core PCE, core CPI, and Cleveland Fed Trimmed-Mean CPI), are currently below 2%, with only the Atlanta Fed s Core Sticky CPI above 2%. Although some transitory or idiosyncratic factors have sometimes temporarily suppressed inflation (such as lower mobile phone contract prices and periodic commodity price changes), these cannot be an explanation of sub-target inflation lasting for such a protracted period. The problem with this conventional approach is that the Phillips curve is an empirical observation rather than a proper theory of inflation. It only looks at two of the final elements in the inflation process (economic activity and wages or prices); it does not describe the entire inflationary process. Since inflation is fundamentally a monetary phenomenon, it should therefore include factors like money and credit growth which are ignored by Phillips curve adherents. An assessment of monetary conditions is, therefore, crucial in understanding and predicting the path of inflation. In a monetary framework, sustained faster growth of broad money (e.g., the growth of M2, M3 or even wider measures, not the level of monetary conditions indicators) first affects asset prices. Then, higher asset prices boost economic activity and reduce unemployment, and stronger real economic growth drives general inflation higher provided there has been sustained faster growth of money. The Phillips curve relationship considers just the final two stages of that chain the relationship between unemployment (or economic growth relative to its potential) and inflation. The fact that it omits any consideration of monetary growth is its real weakness. 3 Annual economic outlook for 2018

4 In the US, M2 growth has been subdued since 2009 (averaging 6.5% per annum), while our estimate of M3 has grown even more slowly (averaging 4.5% per annum). More broadly, across the 35 developed economies of the OECD, money and credit growth have slowed since On average, there has been a two percentage point step-down in OECD money growth since the global financial crisis, accompanied by a similar reduction in the average inflation rate. In my view, this is no coincidence. In this context it is most unlikely there will be a near-term upsurge in inflation. In the US, with real GDP growth of 2.0% to 2.5% and core inflation at 2% or less, nominal GDP growth looks set to remain around 4%. Averaged over several years, nominal GDP growth has shown a close relationship with the trend in government bond yields. This suggests it is hard to see bond yields rising significantly higher, even with the pressures from the Fed s balance sheet reduction. Against this backdrop the Fed has continued with its policy of gradually normalizing interest rates not tightening monetary policy and on Sept. 20 announced the start of a plan to shrink its balance sheet from the October-December quarter. Based on the latest dot plot released with the Federal Open Market Committee (FOMC) statement in September, interest rates are likely to rise to 2.0% to 2.25% by the end of 2018, while the Fed s balance sheet will be declining by $50 billion per month in the fourth quarter of If the Fed is releasing $50 billion per month (or $600 billion per year), this means that the private sector (both domestic and abroad) must purchase an equivalent amount of US Treasuries and agency debt. If these securities are all long-term instruments placed with institutional investors, this could undoubtedly cause some crowding out, raising longterm yields. If, however, a large fraction of the securities are short-term paper and are acquired by the banks, then the market impact will be much less, but this needs to be monitored. Figure 2 US: The Fed will be raising interest rates and shrinking its balance sheet in Monetary policy normalization Fed total assets (actual) (LHS) Fed funds rate (actual) (RHS) Fed total assets (projected) (LHS) Fed funds rate (projected) (RHS) Trillion ($) 1/03 1/05 1/07 1/09 1/11 1/13 1/15 1/17 1/ / Source: Macrobond; Federal Reserve June 14, 2017, and Invesco calculations; interest rates from the Fed s Summary of Economic Projections, Sept. 20, I forecast real GDP growth to reach 2.4% in 2018 and consumer price inflation (as measured by the CPI) to average 1.8% in Annual economic outlook for 2018

5 The eurozone With German Chancellor Angela Merkel engaged in coalition negotiations since the federal election on Sept, 24, the Catalan movement for regional autonomy in Spain still bound up in the courts, and an Italian election scheduled for next year, European political momentum for reforming the eurozone along the lines suggested by French President Emmanuel Macron has stalled recently. The European economic situation has continued to improve gradually, with economic growth for the area rising to 2.6% year-on-year in the third quarter of 2017, the best performance in many years. It is worthwhile to recap Europe s difficulties in reaching this stage of recovery, which owes much to the European Central Bank s (ECB) decision to embark (belatedly) on a quantitative easing (QE) program of asset purchases beginning in March The data show that since January 2015, eurozone M3 growth has accelerated to an average of 4.8% per annum, enabling real GDP to average 2.1% in the three years to the third quarter of 2017, its best and most consistent showing since 2005 through The issue going forward, given the ECB s decision to halve its monthly asset purchases to 30 billion per month between January and September 2018, is whether the commercial banks are willing to take up the credit and money creation baton from the ECB. Current lending by eurozone banks is weak to anemic at best, and if it does not improve, that risks a setback to money and credit growth later in Figure 3 Eurozone inflation still falling below 2.0% target Eurozone CPI and Core CPI (% YOY) CPI all items Core CPI 2.0 % Source: Thomson Reuters Datastream, data as of Dec. 8, Moreover, in view of the wide disparities of economic performance within the eurozone, it is not surprising that loan growth is much weaker in the periphery than in the core economies. For example, in October combined bank lending to Italy, Spain, Portugal, Greece and Ireland was declining at 1.9% year-on-year, while total eurozone lending to private sector companies was only growing at 0.9% year-on-year, not enough to support a 5% growth of deposits on the other side of bank balance sheets. The risk, therefore, is that tapering QE purchases in 2018 will lead to a renewed and potentially damaging slowdown in M3 growth. A downturn in credit growth at this stage of the eurozone s economic recovery would be unfortunate, causing the economic upswing to weaken. Sustained M3 growth of 5% to 6% or more is the minimum needed to ensure 2% real growth and 2% inflation (after allowing for a 1% annual decline in income velocity, or the turnover of money relative to income). However, the preconditions for maintaining this environment are distinctly fragile. In addition, the inflation rate for the eurozone remains well below the target figure of below but close to 2%. The headline rate in November was still just 1.5% year-on-year while the core rate (which excludes the volatile food and energy components) was even lower at 0.9%. All this means that if the ECB does taper its asset purchases to zero after September 2018 and M3 growth slows, the inflation rate could decline even further below its target. For the eurozone as a whole, I forecast real GDP growth in 2018 of 2.2%, and headline CPI inflation of 1.5%, due mainly to inadequate M3 growth over the year ahead. 5 Annual economic outlook for 2018

6 United Kingdom The British economy has slowed in 2017 compared with 2016, particularly as compared with the period from the first quarter of 2013 until the Brexit referendum in June 2016, when real GDP growth averaged 2.4% per annum. In effect, it has slowed from an American growth rate of 2.0% to 2.5% to a European growth rate of around 1.5%. For example, real GDP increased just 0.4% quarter-on-quarter in the third quarter of 2017, and by 1.5% over the preceding year. In contrast to some of the gloomier Brexit forecasts, some areas of the economy remained strikingly buoyant. Nominal retail sales for all four main sectors food, non-food, non-store sales and auto-related were up by 2.8% year-on-year in October (although down by 0.3% in real terms compared with October 2016), and the Confederation of British Industry (CBI) survey of order books is showing its highest positive balance since the boom of the late 1980s. Figure 4 UK: Imported inflation episode ending UK Imports and Sterling TWI (% YOY, 3MMA) Import prices of goods (LHS) Goods prices within CPI (LHS) Sterling TWI (RHS) % 1/08 1/09 1/10 1/11 1/12 1/13 1/14 1/15 1/16 1/17 % Source: Macrobond, data as of Dec. 8, There are two main reasons for growth holding up better than the pronounced weakness forecast by consensus economists a year ago. First, monetary policy has been highly stimulatory, and second, the weaker pound has enabled the manufacturing export sector to be much more vigorous than expected. Monetary policy was already very expansionary at the time of the referendum. Commercial bank lending and money growth had accelerated from 4% to 5% growth rates in the year to March 2016 to 6% to 8% by the end of 2016, well ahead of the preceding three or four years. Then, in the aftermath of the referendum, the Bank of England s Monetary Policy Committee (MPC) added fuel to the fire by cutting the base rate from 0.5% to 0.25%, adding a further 60 billion of QE, and setting up a term lending facility to encourage additional bank lending to industry. The growth of M4x (a measure of money supply that best reflects the spendable funds available to households and businesses) averaged 4.5% year-on-year in January through March 2016, but subsequently accelerated to average 7.0% in the year from July 2016 to June Similarly, consumer credit growth and lending to the financial sector surged to double-digit rates over the same period. These more rapid growth rates of money and credit are the primary source of faster spending growth in nominal terms since mid The second source of higher activity has been the weaker pound. This has enabled export order books of British manufacturers to surge to their strongest growth rates since the late 1980s. Thus, the CBI monthly surveys of domestic and export orders have both shown the strongest results since Also, the composite purchasing managers index (PMI) figure for services and manufacturing has averaged 54.6 in the first 11 months of Nominal exports have surged since September 2016, growing by 9.6% year-on-year in October In line with the typical delayed J-curve response of the external accounts to exchange rate depreciations, further improvements can be expected over the next year. 6 Annual economic outlook for 2018

7 Another positive for the British economy has been the continued strength of the labor market, reflected in very low unemployment, good job growth and a high participation rate. The unemployment rate fell to 4.3% in the three months centered on September, down from 4.8% a year earlier and the lowest rate since Similarly in July through September 2017, total employment increased by 279,000 over the year, reaching million and giving an employment rate of 75.0% (i.e., the fraction of people aged 16 to 64 who were working), up from 74.4% a year earlier. The flip side of these figures is that although average weekly earnings were up by 2.2% (both including and excluding bonuses) in the three months of July through September, total real weekly earnings were down by 0.4% due to the rise in consumer price inflation to 3.0% year-on-year in both September and October. In response to the higher imported inflation rate and the increase of domestically-generated inflation, the BOE has been shifting its position. Initially it viewed inflation as imported and therefore not something that it could control. However, as the evidence of a domestic spending surge accumulated, the Bank has changed its attitude. First, on June 27 it decided to raise the countercyclical capital buffer or capital requirements of banks by 0.5% of risk-weighted assets, equivalent to 11.4 billion. Second, the minutes of the September MPC meeting reported that a majority of members felt some withdrawal of monetary stimulus was likely to be appropriate over the coming months. Third, at the Nov. 2 meeting of the MPC, the BOE finally raised interest rates by 0.25% to 0.5%. Following the announcement on Dec. 8 that the EU recognizes that sufficient progress has been made in the first stage of the Brexit negotiations to move on to other matters (such as the transition terms and trade relations after March 2019), the downside risks to sterling are likely to be considerably reduced going forward. This is consistent with the data in Figure 4 which suggest that the current episode of imported inflation is coming to an end. For 2018 as a whole I forecast 1.4% real GDP growth and 2.4% consumer price inflation. Japan In the third quarter of 2017, Japan s real GDP increased by 0.3% quarter-on-quarter and 1.6% over the previous year (after 0.6% quarter-on-quarter and 1.5% year-on-year growth in the second quarter of 2017) resulting in the fastest pace of economic growth in two years. The increase in real output was driven a 0.5% quarter-on-quarter increase in net exports, and a small 0.2% gain in private sector investment. Personal consumption was a drag on growth, falling by 0.3% quarter-onquarter. Real GDP has now increased for seven successive quarters, its longest growth streak for more than a decade. However, considering Prime Minister Shinzo Abe s much-touted Three Arrows recovery plan (consisting of monetary expansion, fiscal stimulus and structural reform), in particular the huge scale of Japan s QE program (which forms one of the Three Arrows and has already expanded the Bank of Japan s [BOJ] balance sheet to 92% of GDP), the results should have been evident much sooner and should have had a much greater impact on nominal GDP. Current business activity data appear to be reinforcing the proposition that the Japanese economy has turned a corner. In Figure 5, both capital investment in real terms and corporate profits have seen a significant improvement in recent years. Thanks partly to the weaker yen (down 15% since the first quarter of 2013 on a real trade-weighted basis), corporate profits are up significantly this year, rising 22% year-on-year in the second quarter of In addition, the broadening of the global recovery has boosted global trade, helping Japanese exports grow 6.8% year-on-year in the third quarter, double the World Trade Organization estimate of 3.6% growth in world merchandise trade volume in The increase in corporate profits has fed through to improved business sentiment as reflected in the BOJ s Tankan (or short-term survey of business conditions) registering 15, its highest level since the third quarter of With both soft and hard data increasingly positive, it is not surprising that real capital expenditure is also starting to rise more strongly, reaching 18.7% year-on-year since its low point in the final quarter of This can be expected to continue its upward momentum. 7 Annual economic outlook for 2018

8 All of this is occurring despite prolonged tightness in the labor market. With unemployment at 2.8% in October and the job offers-to-applicants ratio at 1.55 (the highest level since the boom of the early 1970s), it is clear that wage-push alone is not going to cause inflation. The current experience in Japan of a tight labor market but low wage growth is strong evidence that the Phillips curve is not a dependable theory of inflation. The relationship is in reality no more than an empirical observation that appeared to work under certain conditions in the past, but is failing at present (not only in Japan but also in the US, Germany and elsewhere) because the underlying driver of both more rapid wage growth and higher inflation namely faster money growth is not present. Figure 5 Japan: Investment and capex seeing upturn Corporate profit and capital expenditure Real capex (RHS) Corporate profits (ex financial sector) (LHS) 1/98 1/00 1/02 1/04 1/06 1/ /10 1/12 1/14 1/ JPY, trillion JPY, trillion Source: Macrobond, data as of Dec. 8, The result is, despite continuing large-scale QQE (quantitative and qualitative easing) by the BOJ, consumer prices have remained stubbornly below its 2% target. Headline inflation was 0.2% year on-year in October, while core inflation (excluding fresh food) was 0.8% and core-core inflation (i.e., excluding fresh food and energy) was also 0.2%. I expect Japanese real GDP growth to average 1.2% in 2018, while some weakening of the yen (not domestic monetary growth) will raise headline inflation to 0.5% for 2018 as a whole. China and emerging Asia With the completion of the 19th National Congress of the Communist Party, what lies ahead for the Chinese economy? Will the Chinese authorities now take the opportunity to address the economy s build-up of debt or will they push ahead with growth to maintain the momentum of the economy? While it is true that President Xi Jinping strengthened his authority at the Congress, it seems doubtful that serious reform of the country s state owned enterprises will proceed. Since the surge of domestic credit in 2014 through 2016, credit growth has slowed to 12% year on year in October, its slowest pace since December In contrast to the previous credit expansion of 2008 through 2010, there was no significant acceleration in broad money growth accompanying the latest credit surge. This time around the Chinese authorities have kept monetary policy broadly stable, while making temporary adjustments to various macro-prudential controls. Therefore, broad money growth has only averaged 12% per annum since 2014 compared to 21% per annum from 2008 through Domestically, the growth of real GDP was reported at 6.8% in the third quarter, in line with targets set by the leadership. However, as shown in Figure 6, following the reduction of excess capacity in numerous state-owned sectors of heavy industry, the Li Keqiang-style estimate of real GDP named after China s premier and based on readily available data surged from early The 14.4% peak growth rate in July reflects the temporary recovery of a number of basic industries such as steel, coal and electricity, although recent data are showing some moderation. On the external side China s exports have also recovered from declines a year ago to 6% year-onyear in the period of August through October. Imports have recovered even more sharply to a peak of 25% in March, slowing to 16.5% in August through October. With both Chinese exports and imports recovering it does seem that the prolonged slump in world trade has turned the corner and is now in a growth phase. 8 Annual economic outlook for 2018

9 Figure 6 China s industrial output has bounced back Chinese real and estimated GDP (% YOY) Official GDP % YOY Estimated GDP (based on Electricity, Rail freight & Real loans) 6MMAV % Source: Thomson Reuters Datastream, data as of Dec. 8, Since China is by far the largest emerging market and also the biggest buyer of commodities on world markets, the growth of China s imports matters immensely to numerous developed and emerging commodity exporters around the world. If China can engineer a steady domestic recovery over the next year or two, the outlook for those commodity-exporting economies will improve considerably. While China on its own cannot be a global locomotive for all commodity-producing economies, the synchronous recovery in the developed economies should provide more positive support for global commodity prices than we have experienced in the last five years. For 2018, I expect 6.6% as the official real GDP growth figure and 1.0% consumer price inflation. Turning to the smaller, manufacturing economies of East Asia which are heavily involved in regional supply chains that include China, the outlook for their exports will depend primarily on the continuation of business cycle upswings in the US and Europe and only secondarily on the domestic Chinese economy. This is because China imports mainly raw materials and capital goods (not made by these economies), but relatively few manufactured goods for its own end-use. By contrast, North America and Western Europe are major importers of the manufactured goods produced by Asian supply chains. In 2018 Korea, Taiwan and Hong Kong are expected to grow at 2% to 3%, while the ASEAN economies are expected to grow at 4% to 5%. Although these real GDP growth rates are generally below past trends, the smaller, export-oriented Asian economies have enjoyed large stock market increases so far this year in response to signs that global trade growth has recovered. Commodities With global real output growth forecast to be 3.1% in 2018 (by Consensus Economics), commodity prices are likely to see only moderate growth, repeating the experience of 2017 when commodity prices such as the S&P GSCI rose just 8% and the CRB index was up only 2%. The energy sector has seen a continuation of price improvement this year, but is unlikely to see a marked upswing next year. In 2017 the iron ore market experienced much volatility and is down 15% year-to-date (as of Dec. 8, 2017). This fall has been offset by an increase in base metal prices. Precious metal prices seem likely to decline if there are continued US interest rate rises. Agricultural commodities have receded modestly in 2017 but most seem likely to stabilize in As always, a lot depends on China and Chinese government policy. Oil remains the big story moving into The second half of 2017 saw a rebound in oil prices; Brent crude is up 27% since June OPEC and other oil producers agreed on Nov. 30 to extend production cuts beyond March 2018, with Russia and Saudi Arabia agreeing to extend their cuts for a further nine months, maintaining the production freeze until the end of The agreement has been successful in raising the international oil price above $60 per barrel, an increase of two-thirds from its low point. Saudi Arabia would like to maintain the production freeze as long as possible in order to take pressure off its stretched government budget and to achieve a generous valuation when it partially privatizes Aramco, the national oil company. Russia on the other hand, while enjoying higher profits, does not want to lose any more market share to unconventional producers. On top of that, Russia has some big oil projects due for completion in 2018 and these may now have to be mothballed. 9 Annual economic outlook for 2018

10 The higher oil prices have also been supported by political events in the Middle East, namely the increasing power and influence of the Saudi Crown Prince Mohamad Bin Salman. The heir-apparent has arrested some of the country s most powerful leaders and wealthiest businessmen, ostensibly as part of a crackdown on corruption, but many suspect the motivation was the consolidation of his power and, to a lesser extent, a shakedown for money to help bolster the country s reduced coffers. He has also engaged in international politics, and in doing so increased regional tensions between Saudi Arabia and fellow OPEC members Iran and Qatar. Market participants fear this could degenerate to such a degree that supply from the world s biggest oil-producing region could be disrupted. The US shale sector remains the major constraint on a significant rise in oil prices. The US rig count is up 38% year-to-date but has retreated slightly since it peaked in July This is still well below its level before the oil price collapse of 2014, which it hastened. Nevertheless, US crude oil production has kept rising, with the latest data putting US production at 9.7 million barrels per day, surpassing the previous record of 9.6 million barrels per day set in Production for 2017 is up by an average of 0.5 million barrels per day through November, according to the Energy Information Administration. OPEC estimates world oil demand is growing at 1.42 million barrels per day. However, with the US and other oil producers such as Iran and Libya increasing production too, there is unlikely to be a surge in oil prices even as global economic growth broadens. Rare metals, especially those that are used in electric car batteries, have received a lot of interest. This has been driven by the conviction that there is going to be a shift to electric cars. Several governments, including those of France and the UK, have promised to ban the sale of new fossil fuel-powered cars in the coming decades. Manufacturers such as Volvo, BMW and Volkswagen have also committed either to produce exclusively or dramatically increase their production of electric vehicles in the coming years. Whether these promises and commitments are actually fulfilled remains to be seen. Cobalt, which is used in the cathode of electric vehicle batteries, has seen its price on the London Metal Exchange rise over 100% since the beginning of 2017, more than any other battery metal. There are concerns that the supply of cobalt will not be able to meet a rise in demand. The main producer of cobalt currently is the Democratic Republic of Congo, one of the most impoverished and politically volatile countries in Africa. However, as with previous scares about the scarcity of rare earths, high prices tend to spur new discoveries of the raw material or expansion by existing producers. There will likely also be technological responses such as raw material substitution or efficiency gains. But until technology and new supply responds, and as long as the march towards electric propulsion continues, the prices of cobalt and other materials used in the production of electric cars are likely to remain elevated. Figure 7 Commodities: Modest improvement in outlook Commodity prices (Jan 2008 = 100) S&P GSCI commodity spot CRB index Source: Macrobond, data as of Dec. 8, Annual economic outlook for 2018

11 Conclusion The global business cycle expansion has broadened and strengthened in 2017 and will likely continue to strengthen in 2018, led by improvements in the US and the eurozone, and steady contributions from China and India. Many emerging economies, especially the smaller, manufacturing economies of East Asia and the Americas, will benefit from these trends which have already been reflected in their stock market performances in While the global upswing is solid, it is not spectacular, and I therefore expect a moderate but positive response from commodity prices during It now looks highly likely that the current expansion will become the longest business cycle expansion in US financial history, exceeding the record trough-to-peak expansion of 120 months between March 1991 and March 2001 (as measured by the NBER) and presided over by Alan Greenspan, who led the Fed at that time. The only real threat to this prospect is the possibility that central banks make a mistake and tighten too much during the coming phase of monetary policy normalization. However, as long as below-target inflation rates continue across major economies, it will remain possible for central banks to slow the normalization process, further extending the cycle. Explore High-Conviction Investing with Invesco All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This is not to be construed as an offer to buy or sell any financial instruments. This does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Where John Greenwood has expressed opinions, they are based on current market conditions as of Dec. 8, 2017, and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals. Unless otherwise specified, data was supplied by Mr. Greenwood. Past performance is not a guarantee of future returns. An investment cannot be made in an index. Invesco Advisers, Inc. and Invesco Distributors, Inc. are indirect, wholly owned subsidiaries of Invesco Ltd. invesco.com/us IVZ-JGANN-INSI-1-E 12/17 Invesco Distributors, Inc. US14686