Global Outlook (December 2016/January 2017)

Unusual Uncertainty in 2017

"Political turbulence means that there is more uncertainty over the global economic outlook than there has been this decade. The risk of recession – perhaps due to “boom-bust” – has risen.”

– Richard Jerram, Chief Economist, Bank of Singapore

  • Previously there was no prospect of a U.S. recession within a realistic time frame. Mildly-loose policy was allowing a gradual absorption of excess capacity. This no longer seems to be an appropriate framework.
  • The two factors that usually cause a downturn are an exogenous shock or domestic overheating, that leads to monetary tightening which hurts growth. Both are possible now. The former could stem from tariffs that damage global trade, the latter from fiscal stimulus into an economy already near to full capacity. There is now a realistic risk of a recession in Trump’s first term in office, perhaps by 2019.
  • More positive outcomes are also possible. Judicious deregulation and targeted fiscal spending could raise the potential growth rate, especially if accompanied by restraint on trade policy. This could produce a “stronger for longer” expansion. This outlook will need to be revised as the policy direction of the new Trump administration becomes clearer.
  • The Eurozone is at risk of the disruption seen in the U.K. and U.S. in 2016, with several important political elections and events in the coming year. Rising anti-EU sentiment in the founding members of the EU is a particular concern. Even if the survival of the EU is not seriously threatened, it is becoming harder to implement reforms that would improve the stability of the region.
  • More positively, the anti-EU sentiment seems to have contributed to acceptance of a slight loosening of fiscal policy, which will help to support growth in 2017 and 2018. Unlike the U.S. and Japan, the Eurozone still has significant excess capacity.
  • Japan’s economy is around full employment even though growth has averaged just 0.7 per cent over the past five years. Economic activity is only slightly greater than pre-crisis levels in 2008 which is a useful indication of the drag that demographics is having on productive capacity. Growth is set to be a little more rapid in 2017 due to fiscal stimulus and the weaker exchange rate, but this will just be a short-term lift.
  • In Asia, China remains a significant medium-term risk. Rapid lending, high investment rates and slowing economic growth is a combination that suggests an inefficient allocation of credit and an eventual bad debt crisis. In China the process is largely internal – so no Lehman shock – and dominated by the state, which implies the consequence is that the growth rate grinds lower, rather than the system explodes.
  • After Mexico, Asia is most exposed to U.S. tariffs. Restrictions on U.S. imports from China would affect the entire region through the impact on the extended supply chains. Moreover, the U.S. has large trade deficits with many other Asian economies, even before we consider their exports that go to the U.S. via China.