The outlook for the global economy in 2018 remains strong, according to Ethan Harris, head of Global Economics at BofA Merrill Lynch Global Research. Below he outlines his forecasts for the coming year and three key risks investors should keep an eye out for.
In recent years, we have regularly started the year with a 3.5% growth forecast for the global economy, only to lower the forecast to 3.0% over the course of the year. This past year broke that pattern: We started 2017 at 3.5%, but have revised that higher to 3.7%. Looking ahead, we expect more of the same, with solid 3.8% potential growth in 2018. And in general, we expect most major economies to grow at or above potential.
Within that backdrop of steady global growth, we see both downside and upside risks in the year ahead.
Perhaps the biggest downside risk is a rise in trade protectionism. A key aspect of the recent growth recovery has been a strong rebound in global trade. While our baseline forecast assumes only small protectionist measures, we can’t rule out a sudden breakdown in NAFTA, U.S.-China relations or other trade negotiations. As we have argued in the past, everyone loses in a trade war.
U.S. tax reform has mixed implications for the outlook. If recent proposals pass, we could see a boom-bust scenario. If the full cut passes it could add a few tenths of a percentage point to growth in 2017 and 2018. However, with the U.S. already at full employment, this could cause the economy to overheat, triggering the Federal Reserve to raise interest rates faster than expected. This increases the risk of a policy mistake.
Finally, the biggest upside risk to our global outlook is even stronger growth in capital spending. Businesses were deeply skeptical coming out of the great recession, but the recent mini-boom in global trade and growth seems to be impacting business confidence and capital expenditures in the U.S., the Euro area and Japan. A continuation of this trend would be very good news as it could increase productive capacity and extend the economic expansion.
Note: This article is adapted from the BofA Merrill Lynch Global Research paper: Global Economics 2018 Year Ahead (Nov. 19, 2017).
Three key factors should drive the economic picture in the U.S. in 2018, according to Michelle Meyer, head of U.S. Economics at BofA Merrill Lynch Global Research. Here’s what to watch out for.
As we look ahead to 2018, we think the focus for the U.S. economy will remain on inflation and policy developments. We see three dynamics at play:
1. The big story in 2018 will be inflation. We expect a rebound from 2017 as further tightening in the labor market sets up for higher inflation, albeit gradual.
After the experience in 2017, we should accept that there are structural forces holding back inflation. However, as we forecast the unemployment rate to potentially drop to 3.9% by the end of 2018, we think wage inflation should show through. In our view, the structural dynamics resist — but do not stop — the cyclical forces. We expect core personal consumption expenditure (PCE) inflation to likely rise to 1.8% at the end of the year and 2.0% by end of 2019.
2. The Federal Reserve’s job of setting interest rate policy becomes more complicated. We expect continued hikes in the benchmark federal funds rate, but with risks of communication missteps.
The Fed’s latest rate hike in December 2017 marked the transition from “removal of accommodation” to “tightening.” That is, the three interest rate hikes we have priced in 2018 will no longer be normalization but true rate hikes. The test will be how the market reacts. We are expecting the Fed to hike twice in 2019. A challenge for the Fed will be a change of leadership which could make communication with the market more complicated.
3. The main upside risk to growth would be the passage of tax reform while the downside is from trade battles. The midterm elections in November 2018 may create complications.
Fiscal policy presents risks to our forecast both on the upside and downside. On the one hand, the passage of deficit-financed tax cuts could stimulate stronger near-term growth. On the downside, we continue to see risks relating to trade policy with the possibility of NAFTA negotiations falling apart.
In sum, we expect inflation to trend higher but still struggle to reach the 2.0% target while growth in the economy runs modestly above trend. Fed policy is unlikely to be as straightforward as in 2017 given the change in leadership at the Federal Reserve and proximity to neutral rates.
Note: This article is adapted from the BofA Merrill Lynch Global Research paper: Global Economics 2018 Year Ahead (Nov. 19, 2017)
What Will Fuel Economic Growth in 2018?
In the coming year, Michelle Meyer, head of U.S. Economics, forecasts the U.S. economy will grow at a healthy 2.4%, supported by the following four trends:
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