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Global Economic Update - April 2018

Chief Economist

Trump’s aggressive rhetoric on trade in combination with higher market volatility is weighing on sentiment. Even though some leading indicators suggest that the pace of the recovery is slowing, economic indicators remain solid. Things could of course quickly escalate.

 

Our base case scenario remains that the US and China will eventually strike some form of agreement. Most economic figures are holding up nicely from a cyclical point of view. Trade volumes are still growing, corporate profits are on the rise and unemployment rates are reaching new lows. The combination of loose monetary policy, relatively low commodity prices and neutral fiscal policy has come to fruition.

So far, however, this is only modestly translating into rising wage and inflation readings. There has been a lot of talk about the death of the Phillips curve but it might be premature to confirm that message. Inflationary pressures are firming and we expect this to continue. That said, other factors including globalization, technological change and digitization, the ageing of the population, insufficient labour union power, lower anchored inflation expectations and sluggish productivity growth suggest that the negative relationship is weaker than before.

Financial conditions look set to become tighter from here eventually biting into economic activity, perhaps already later this year. The business cycle is looking increasingly mature, especially in the US where unemployment and household savings rates are hitting new lows. Meanwhile, the yield curve continues its flattening trend and the stock market is plateauing. That said, recent bouts of volatility are still not enough to deter the Fed from changing its course. As things currently stand, we expect the Fed to raise rates a total of three (perhaps four) times in 2018.

The Eurozone recovery is slowing down. Yet, even at a slower pace, the cyclical recovery picture remains in place. Economic slack is still abundant. Hence, it does not come as a surprise that inflation continues to fall short of the ECB’s 2% target. It is too soon for an actual rate hike, and this will only come well after the ECB has put an end to its asset purchase program later this year. The first rate hike probably won’t come before the summer of 2019. 

As also noted by the IMF in its most recent economic update, risks have increased over the past six months in line with rising geopolitical and trade tensions. Looking ahead, structural issues still cloud the horizon. China’s economy has settled down from earlier hard landing fears but there’s evidence that growth is decelerating again. In the US fiscal policy is on an unstainable path. Meanwhile, the Eurozone is nowhere near completing its monetary union. Finally, recent years of low interest rates - needed to support economic growth - have provided an environment in which financial vulnerabilities have been building.

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