As the outlook for global growth continued to improve, central banks in advanced economies proceeded with policy normalization despite persistently soft inflation. Economic activity appeared more robust in recent months across most major economies, particularly in the US and the eurozone. In the US, growth was bolstered by the promise of a fiscal boost from the GOP’s planned tax cuts. As a result, equities continued to record new highs. Yet, despite the robust growth, inflation has failed to gain further momentum in recent months. The latter has not, however, derailed or changed central banks’ normalization plans. Economic conditions in the US further appear broadly robust, with signs that GDP growth is set to pick up pace in 4Q17.
GDP growth was solid in 3Q17, at an annualized 3% q/q and rising to 2.3% y/y. The Atlanta Fed’s GDPNow forecast now sees growth in 4Q17 at an annualized 4.5%, implying y/y growth of nearly 3%. A number of leading indicators have been particularly strong, including capital goods orders and the ISM manufacturing index. They tell a story of increased optimism and rising investment. The labor market has also continued to tighten. The latest employment report showed 261,000 new jobs in October and the unemployment rate fell to a 17-year low of 4.1%. Some of the buoyancy in the US economy has come from the prospect of a fiscal boost from President Trump’s tax reform plans.
Since Donald Trump’s election a year ago, markets have been excited over some of his economic proposals. While there have been some concerns that his agenda has seen few legislative wins, the tone has changed in recent weeks particularly in regards to tax reform. Of course, markets anticipate a healthy fiscal stimulus from such legislation in addition to the promise of improved business conditions for companies over the long term. Indeed, GOP legislators in the lower house recently unveiled a comprehensive tax plan, which Trump could sign into law this year or early next year.
Despite the strength in economic activity, inflation has stubbornly failed to gain traction. Wage growth in October was disappointing. Growth of employee wages slipped to 2.3% y/y in October after two months of stronger figures. Core inflation also came in below expectations in September. Core prices rose by just 0.1% m/m, though the annual pace was steady at 1.7% y/y. Inflation in the PCE deflator, a key focus of the Fed, was also subdued in September. The Fed has hinted that soft inflation is unlikely to derail its normalization of monetary policy. Analysts initially feared that softer inflation might prevent the Fed from raising rates in December. Markets are now nearly certain of a hike in December.
While this change is driven in part by clear signs of robust growth, the Fed has also made it clear it is not likely to be swayed by the softer price data. While the market has shifted to being more certain on a December hike, the consensus remains for 2-3 hikes in the next 12 months, implying just 1-2 hikes in 2018. This remains somewhat less optimistic than the Fed’s own median projections of three 25 bp hikes in 2018. Meanwhile, the White House’s choice of Jerome Powell to lead the Fed, starting in February 2018, has assured analysts that monetary policy is likely to be broadly unchanged after current Fed Chair Janet Yellen completes her term. Economic activity in the eurozone has continued to do well, though inflation has not kept pace there either.
The economic figures have broadly been surprising to the upside. Industrial production, PMI and GDP growth have all continued on the firm side in recent months. Indeed, the IMF, once again, upped the eurozone’s GDP forecast in its September World Economic Outlook (WEO). Still, and just as in the US, inflation has remained relatively weak; core inflation in October stood at 0.9% y/y, well below the 2% target, with little sign of momentum. Despite downbeat inflation, the stronger economy has seen the ECB move to wind down its QE program. The European Central Bank announced it plans to reduce the size of its asset purchase program starting in January 2018 through at least September 2018.
The bank will now be buying around 30 billion euros a month, down from 60 billion euros. The move, which was broadly expected, points to the ECB’s confidence in the economic recovery, but also indicates that ending QE will be done gradually, especially in view of the weakness in inflation. The Japanese economy maintained a healthy pace of growth, with the outlook bolstered by Shinzo Abe’s strong showing in the recent election. With Abe clinching a large majority, the PM has strengthened his hand in his efforts to reform the economy and maintain support for the recovery. The IMF revised its growth forecast for Japan in its latest WEO to 1.5% in 2017, though that pace is not expected to be maintained in 2018. Growth is expected to halve to 0.7% in 2018.
With inflation still weak, there is no indication that Japan is even thinking of unwinding its own QE program anytime soon. Emerging markets continue to recover, with the pace in some key economies improving. The IMF expects growth in emerging and developing economies to improve to 4.6-4.9% in 2017 and 2018. In most regions, including China, projections have remained steady. China’s growth has surprised slightly on the upside, with the IMF seeing growth at 6.8% in 2017, though China will continue to see a moderating trend going forward. At the same time, growth in some markets, including commodity driven Brazil and Russia, and developing Europe, has been more resilient than previously expected.
The global economy has not looked better than it does today in a long time, and this has supported the price of oil. Brent rose past $60 per barrel in October; it is now 50% higher than lows registered in June 2017. Oil prices were also bolstered by recent talk of a further extension of production cuts by OPEC and some non-OPEC countries, and by some recent tensions in the Gulf region. Nonetheless, the recovery in oil prices will be limited by the resilience of US shale oil production and prices are not likely to move much higher above current levels in the near term to medium term.
By National Bank of Kuwait