In the second half of 2016, the growth premium favored Developed Markets (DMs) vs Emerging Markets (EMs) – with DMs regaining the macro momentum lost in the first part of 2016. We now expect DMs and EMs to display similar, moderately paced GDP growth going forward.
The US, Eurozone and Japanese economies have been accelerating while the UK has shown a certain degree of resiliency, so far, in the wake of the UK Referendum. At the same time, China’s growth is holding up well and the commodity space has steadied, allowing EM economies to maintain their overall momentum.
The growth outlook for 2017 is constructive, but still lacks a structural engine to make growth sustainable and inclusive over the long term, with a proper increase in productivity rates. Monetary and fiscal levers will be necessary to keep economies moving forward. Household consumption, together with exports, are leading the way as there is the right mix of exported products and country exposures, but private capex continues to struggle.
GDP Growth Outlook 2016-2018
Inflation dynamics are finally creeping upward as base effects kick in. In 2017, inflation rates will be driven by the cost side more than demand pressure. Only in the US will an inflation rise be supported by some overheating in the economy, with pressure coming from a labor market in full employment and increased fiscal stimulus coming from the newly elected President. In Europe and Japan, inflation levels should increase mildly, while likely remaining well below Central Bank (CB) targets. In EMs, the inflation outlook is very benign, with levels expected to approach or to stay within CB targets. (Please see attached graph – GDP Growth Outlook 2016-2018)
In the case of China, risks to the inflation outlook are to the upside. Producer price indices are rising, but are expected to remain under control absent another strong year for global commodity prices.
On Central Banks we believe that the US Federal Reserve faces no particular constraint as it pursues the normalization of monetary policy. In fact, the effort might be slightly accelerated by the incoming President’s economic policy. The rest of the DM space is expected to keep a very accommodative monetary policy stance for the time being: inflation in Europe and Japan is still low or very low, while in the UK, although inflation is expected to go above target soon, an easing stance is supported by possible economic deterioration related to Brexit implementation.
The Federal Reserve’s stance is acting as a constraint on easing within the EM space. In most EM countries, GDP is growing below potential and inflation is heading towards CB targets. These domestic macro conditions are conducive to a certain degree of monetary easing; however, tighter global financial conditions will prevent this much needed policy shift, in our view.
We think that 2017 will be the year when the emphasis will shift from monetary to fiscal policy. As noted earlier, global monetary policy is becoming slightly less accommodative as the Federal Reserve pursues normalization, but the overall stance will likely remain accommodative. On the fiscal side the stance will become easier, to widely varying degrees country-by-country. However, the path to fiscal easing will not be an easy one. Debt has piled up since the Great Financial Crisis and, for the sake of stability and to preserve future growth, monetary policy has carried the burden so far.
The newly elected US President appears to be acting as a further catalyst for the ongoing global debate on fiscal policy. While the outlook on fiscal policy implementation in the US is uncertain, the focus is expected to be on tax rationalization and reduction, in the short-term, rather than on direct expenditures. As a result, we expect any near-term rise in GDP growth to be only marginally tied to addressing productivity.
In Europe, expectations remain very low with respect to any broad and significant easing on the fiscal side. Although, in some countries we have seen less reliance on fiscal policy due to continued weak macro conditions.
Japan continues to implement the ambitious fiscal package announced last August: a decent Second Supplementary Budget (around 0.6% of GDP) was approved in 2016, with some impact expected in 2017.
In EMs, the principal constraint is represented by the outlook of rating agencies on fiscal sustainability for each country. However, conditions are very heterogeneous; those countries that can afford it, being less fragile, are ready to use the fiscal lever. Commodity performance is a useful parameter to evaluate winners and losers among exporters and importers. In China, fiscal easing will remain strong and supportive, especially if signs of a slowdown return.
Even though we expect slightly stronger economic growth in 2017, we continue to see a number of structural risks on the radar mainly linked to the Fed normalization path, US policies on geopolitics, Eurozone politics and the China mismanagement of the transition and reforms.