The global economy looks poised to slow moderately from 3.8% in 2018 to 3.5% in 2019, led by deceleration in the US and further softening in China. But with growth still above potential in most DM economies, we look for continued labor market tightening, gradually rising core inflation, and in many cases higher policy rates.
Our Fed call remains hawkish relative to the market, with five more 25bp hikes to a terminal 3¼-3½% funds rate at the end of 2019. While higher rates and tighter financial conditions should help slow growth to its potential rate over the next year, we expect a decline in the unemployment rate to 3% and a rise in core inflation to 2¼% by early 2020. We think concerns about the global impact of tighter Fed policy are overdone. Spillovers to EM are real, but the market has already priced 11 of the 13 hikes we expect for this cycle, so most of the adjustment to more normal US interest rates is probably behind us. The main risk to this view is a more substantial US overheating that eventually forces steeper rate hikes.
China has slowed quite sharply in 2018, on the back of slower credit growth and fears about a more damaging trade war. With monetary and fiscal policy now in easing mode, we expect only a modest further deceleration. The macro impact of increasing tariffs is also likely to remain manageable, even under our call for some further escalation in early 2019.
Although growth in Europe and Japan has decelerated in the course of 2018, it remains above trend. This should put further downward pressure on the unemployment rate and keep the recent upward trend in wage growth intact. However, with core inflation still far below the target, the Italian budget crisis unresolved, and Brexit negotiations ongoing, the risks to our forecasts of a first hike in the ECB deposit rate in Q4 2019 are tilted to the later side.
Beyond 2019, the risk of a global recession is likely to rise as more and more DM economies move beyond full employment. However, even in subsequent years recession is not our base case. Financial imbalances still look very limited, and the flatter and more anchored Phillips curve has reduced the need for central banks to reverse an overshooting of full employment quickly.
2018 Year In Review
January 10 - Talk of a cryptocurrency bubble escalates.
January 24 - US sparks fears of trade war as Trump heads to Davos
January 31 - Yellen successful term as Fed Chair comes to an end
February 8 - Market volatility comes back!
February 15 - U.S. 10-year yield approaching key 3% mark
March 8 - Trump tariffs spark global trade war fears
March 21 - Facebook firestorm continues over third parties' access to user personal data
March 29 - FAANG stocks hit hard as tech backlash grows
May 30 - Euro break-up odds rise as investors fret about Italy drama
June 14 - PERFECT WEEK OF THE YEAR - Trump/Kim summit, Fed, ECB and World Cup
August 9 - S&P 500 almost back to all-time highs
August 30, 2018 - FAANG stocks continue to lead the market higher
October 30 - It’s Trick-or-Treat time for the bulls and bears!
December 26 - DOW JONES +1086 (+4.98%)
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