The expectation that the incoming Trump administration will enact sizeable fiscal stimulus has increased optimism about the United States and global growth. This, in turn, has pushed US stock indexes to record highs, while pushing up both interest rates (with a resulting rout in the bond market) and the dollar.
A stronger dollar is mostly good news for Europe and Japan, helping to boost both export growth and inflation expectations. On the other hand, much higher US bond yields are bad news for the emerging world, where currencies have already taken a beating in recent weeks, significantly reducing the scope for further monetary easing.
Fortunately, these financial-market gyrations are occurring at a time when commodity prices are rising and both consumer and business sentiment have improved. IHS Markit believes that the balance of these trends will be moderately positive for global growth, which is expected to increase from 2.4% in 2016 to 2.8% in 2017, and 3.1% in 2018. That said, high levels of political and policy uncertainty could hurt growth in 2017 and beyond.
These are our top risks for the economy:
1. The US economy will accelerate – even before any Trump stimulus. During the coming year, a much smaller drag from inventories and a rebound in energy-sector capital spending will boost growth to 2.3%, from 1.6% in 2016. Moreover, with tax cuts and infrastructure spending likely to be enacted next year, growth will pick up to 2.6% in 2018. Consumer and business confidence, which rebounded right after the election, are likely to be boosted further as growth improves. On the downside, the rise in both interest rates and the dollar, in anticipation of stimulus, will erode some of the positive effects of stimulus.
2. Europe’s economic momentum will slow a little, primarily because of Brexit and political uncertainties. A contentious Brexit, the fallout from the recent referendum defeat in Italy, and upcoming elections in France, Germany and the Netherlands could all hurt growth next year. In particular, the political turmoil in Italy could trigger a crisis in the banking sector, which is already in dire straits. On the positive side, the European Central Bank has extended its bond-buying programme (albeit at a more modest pace), and a weaker euro will help to lift export growth and (along with rising oil prices) raise inflation rates. IHS Markit continues to believe that these conflicting forces will weaken Eurozone growth from 1.7% in 2016 to 1.4% in 2017.
3. Japan’s economy will gain a little traction, thanks to a weaker yen. In recent years, Japan’s economy has struggled. Going forward, a weaker yen will help boost exports and lift the economy out of deflation. The demise of the Trans-Pacific Partnership diminishes the chances of meaningful structural reforms in Japan. On the other hand, the fiscal package passed by Japan’s parliament in October, albeit modest, will provide earthquake relief and more infrastructure spending. On balance, IHS Markit believes that Japanese growth will stabilize at around 1.0% in both 2017 and 2018.
4. China’s growth will grind down further, led by a housing construction slowdown. The Chinese government is in the process of removing stimulus. This will hurt the housing sector, construction and heavy industries, lowering real GDP growth from 6.7% in 2016 to 6.4% in 2017. China also faces another source of stress because of capital flight. Foreign exchange reserves are at a five-year low and the renminbi is back to 2008 levels. In response, the government has already imposed some capital controls and will likely do more soon – in an attempt to relieve pressure on the currency and limit annual depreciation to no more than 5%.
5. Emerging markets will do better, despite recent financial market pressures. With moderately stronger US and global expansions and rising commodity prices, emerging markets should do better over the next year. However, capital flight and depreciating currencies are creating headaches for some central banks. On the downside, plunging currencies are unwelcome for at least two reasons. First, to prevent further capital flight, central banks have to pursue more restrictive policies than they would like. Second, dollar-denominated debt in the emerging world has risen rapidly in recent years, reaching around $3.5 trillion. As the value of the dollar goes up, so does the burden of these debts. The good news is that the economic fundamentals (e.g. current-account deficits) in most emerging markets have improved in the past couple of years.
