Major Economies Economic Outlook December 2016

Trump government means short term boost to growth but more volatility

Major Economies: Trump government means short-term boost to growth but more volatility

November 23, 2016

Donald Trump was elected the 45th U.S. President on 8 November and his platform based on “America first” is expected to have profound global ramifications. Many of President-elect Trump’s policy proposals lack detail and clarity will only emerge in the coming weeks as he assembles his Cabinet and establishes his relationship with Congressional Republicans. The Consensus among economists is that Trump’s policy proposals—higher tariffs on trade, curbing illegal immigration, increased federal stimulus and tax cuts for corporations and wealthy U.S. citizens—are likely to provide a short-term boost to U.S. economic growth, yet they will be detrimental for the global economy in the medium to long term.

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From late January, Trump will have the authority of the Executive and the support of a predominantly Republican Congress to forge ahead with his economic plans to revive an economy that is growing, but still remains fragile. He is set to cut taxes dramatically and increase spending on defense and infrastructure, although the details of these plans have not yet been specified. Furthermore, his government will come at a time when the global economy is expected to gain gradual momentum from the lackluster performance that it has showed in 2016. An early estimate produced by FocusEconomics shows that global GDP growth had ticked up from 2.4% in Q2 to 2.6% in Q3 and remains on track to grow 2.5% overall this year, as economists have been forecasting since September.

In the first half of 2017, economists expect that the global recovery will strengthen, with an average projection of 2.8% growth in that period. This likely reflects a pickup in the U.S. economy, due to the expected stimulatory first effects of Trump’s policy platform, and a recovery in global trade and commodity prices, which will prompt faster growth in many emerging economies. That said, in the near term, all eyes will be on market reactions, as the global financial markets are expected to be attuned to any policy changes in the U.S. Consequently, volatility—rather than a bear market—is expected to be the most probable outcome, given the lack of clarity as to what Trump’s priorities will be.

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Protectionism and trade

Key features of Trump’s campaign rhetoric were greater protectionism and a more unilateral foreign policy—areas where the U.S. executive has significant scope for maneuver and which are the main sources of spillover effects to the rest of the world. Others included Trump’s efforts to boost domestic growth through fiscal stimulus, with potential knock-on effects in the financial and commodity markets. Trump’s plan to “rebuild the American economy by fighting for free trade” stems from his dissatisfaction with existing free-trade agreements.

The renegotiation of the North American Free-Trade Agreement (NAFTA) will have direct consequences for Canada and Mexico, both of which send over 70% of their exports to the U.S. Data suggest that Mexico will be more exposed if the U.S. renegotiates NAFTA, given the deep integration of some industries between the two economies. As for the Transatlantic Trade and Investment Partnership (TTIP), Trump has not made any clear statement to date on his intentions but he is likely to halt negotiations for the time being, which for Europe means that faster growth in trade with the U.S. will not materialize any time soon. A major shift towards trade protectionism in the U.S. also has the potential to have a significant impact on Asian economies. Trump has called for a withdrawal from the Trans-Pacific Partnership (TPP) and threatened to label China a currency manipulator and impose punitive tariffs on Chinese imports. While the Republican has also heavily criticized the U.S.–South Korea FTA, Asian exporters have become less directly dependent on the U.S. over the last two decades, as China has become a more important market for most of the region’s economies. However, the U.S. remains the largest trade partner for China itself and any disruption to trade between the world’s two largest economies would have serious economic consequences for the region and the world.

While it is difficult to imagine new trade deals being completed and it will not be straightforward to reopen or scrap existing ones, Donald Trump has sufficient leeway to unilaterally impose temporary restrictions. Such moves are likely to encourage other countries to retaliate with punitive restrictions of their own, which, in the worst case scenario, could start trade wars. 

Reaction in commodities, currencies and bonds

Developing economies that typically produce and export commodities and basic goods—rather than high value-added products that are substitutes for U.S.-produced goods—would be less directly affected by expected higher trade barriers. Global commodity prices are key to healthy public finances in many emerging economies as well as to their sovereign credit ratings.

Commodity prices under Trump’s presidency will depend on several factors, not least global trade and global growth prospects. Base metal prices, in particular for aluminium, copper, iron ore, lead and zinc, all rose immediately following Trump’s victory, in reaction to prospects of greater U.S. infrastructure spending. Also, after plunging dramatically in the aftermath of the election, U.S. equities have recovered swiftly as hopes of an economic stimulus appear to be driving sentiment toward risky assets.

The prospects of higher fiscal stimulus and rising U.S. inflation expectations have pushed up U.S. Treasury yields. Similar movements have also occurred in other developed economies’ bond markets. Meanwhile, a strengthening U.S. dollar and concerns regarding Trump’s anti-globalization sentiment have prompted sovereign bond yields in emerging markets to rise sharply and emerging currencies to fall abruptly since the election. If this trend continues, it will have serious negative implications for those developing economies with significant foreign currency debt burdens.

Isolationism and increase in defense costs on the cards

Trump’s foreign policy vision is achieve “peace through strength” and to “advance America’s core national interest, promote regional stability, and produce an easing of tensions in the world”. However, it is unclear what approach he will take to achieve this beyond isolationism and a case-by-case approach to immediate issues. Trump has expressed his desire for the U.S. to maintain its NATO membership, but he has described it as “obsolete” in its current format and would also like to see European countries contributing a larger share of the defense bill. At the same time, the president-elect has spoken favorably about Russia’s President Vladimir Putin and may take a more accommodative approach towards bilateral sanctions and Russia’s attempts to extend its sphere of influence. This might have negative implications for Ukraine.

Potential U.S. military retrenchment or conditionality has the potential to increase defense spending in Asia, Europe and the Middle East, which would add pressure on loosening fiscal policy in these parts of the world. Trump’s view on NATO has caused particular concern in the Baltic countries, where Estonia exceeds the NATO defense spending target of 2% of GDP. Latvia and Lithuania plan to hit the target in 2018, but are relying on new revenues to finance it.

Meanwhile, Donald Trump has said that Asian allies of the U.S. should take more responsibility for their own security and even suggested that South Korea and Japan should develop their own nuclear weapon capabilities. This approach, if it materializes, could increase military spending and give China an opportunity to expand its strategic presence, empowering Asia’s giant in areas of tension, such as the South China Sea. Regarding the Middle East, Trump has indicated that Gulf States should become more militarily self-sufficient, which could cause fiscal complications given the already battered public accounts of these economies.

Global growth to strengthen next year but uncertainty persists

For the U.S. economy, and hence the global economy, Trump’s presidency is expected to bring positive effects in the near term on the back of a fiscal stimulus package he has pledged. However, the longer-term effects of Trump’s initiatives have the potential to cast a dark shadow on the global outlook. Global growth prospects were stable this month as near-term risks appear to be balanced. According to the analysts surveyed by FocusEconomics this month, the world’s economy will increase 2.5% in 2016, which, if confirmed, will represent the weakest growth since 2010, when the global economy started to recover from the financial crisis. This year’s disappointing deceleration has stemmed from slower growth in the Eurozonethe United Kingdom and the U.S., as well as across most of the developing world, led mainly by China. Heading into 2017, the global economy is expected to strengthen and expand 2.9%, supported by the continued recovery in developed economies—bolstered by still accommodative monetary policies in some economies and renewed fiscal support in others. Our 2017 global growth forecast was left unchanged this month, which reflects that downside risks to the outlook stemming from potential struggles to negotiate Brexit, a potential sharp slowdown of the Chinese economy (given its extreme indebtedness) and a deterioration in global trade could be compensated for by greater emphasis on fiscal stimulus, particularly in the U.S. Needless to say, analysts’ assumptions regarding the economic outlook for the U.S. and global economies are subject to a great deal of uncertainty at this early stage and will likely change over time.

Looking at individual countries, this month’s global outlook for 2017 reflects unchanged growth prospects for major economies such as Canadathe Euro areaJapan and the United States. Meanwhile, the GDP growth forecast for the UK improved from the previous month as concerns over negative spillovers from the Brexit vote continued to reduce.

Among emerging economies, the outlook for most regions—Asia ex-Japan, Eastern Europe, Latin America and the Middle East and North Africa—was held stable from the previous month’s Consensus. That said, the outlook for Sub-Saharan Africa deteriorated for the ninth consecutive month, as the region continues to be threatened by mounting domestic challenges.

UNITED STATES | Trump’s win triggers another blow to pollsters

The Republican Party has swept into the U.S. Congress and the White House with Donald Trump’s election win, in yet another blow to pollsters and pundits, following failures to predict the Brexit outcome and the peace agreement in Colombia. Both the House of Representatives and the Senate, as well as the Oval Office, will be controlled by the Grand Old Party (GOP) for the first time since 2005–2007 under the administration of President George W. Bush. Analysts and market participants are still digesting the aftermath of the election and while the U.S. economy continues to expand at a moderate pace, supported mainly by solid private consumption, economic policy developments from the new administration will be of chief importance in the near term and through the first 100 days in office.

After a lackluster H1, the U.S. economy picked up momentum in Q3 and remains on track to grow 1.5% in 2016 overall, according to our Consensus Forecast this month. Solid growth in consumer spending has supported the world’s largest economy, which is projected to firm up next year and increase 2.1%. The 2017 growth outlook, which is unchanged from last month’s forecast, remains subject to the as of yet uncertain evolution of economic policy under Trump’s presidency.

EURO AREA | Growth remains sluggish

The Eurozone’s modest growth trajectory continued in the third quarter, unfazed by the surprise vote for Brexit. GDP growth was stable at Q2’s 0.3% over the previous quarter in the third quarter, according to a preliminary estimate. Although details for the quarter are not yet available, solid domestic demand likely drove the reading, while the external sector remained hampered by subdued demand. The unemployment rate inched down in Q3 and ultra-low interest rates combined with near-zero inflation are boosting consumption. Early data for the fourth quarter suggests growth remains on an even footing: economic sentiment hit the highest level this year in October and the composite PMI rose further into expansionary territory. Meanwhile, the euro fell to the lowest level seen in nearly one year in November amid heightened market volatility following Donald Trump’s election in the U.S.

The Eurozone’s growth story remains largely unchanged as supportive monetary policy, an improving labor market and a less austere fiscal stance are fueling the economy’s momentum. However, political risks to the outlook remain elevated amid rising support for populist parties, a jam-packed election calendar in 2017, Brexit and an unexpected regime change in a key trading partner. The FocusEconomics panel sees GDP growth slowing from 1.6% in 2016 to 1.4% in 2017, which is unchanged from last month’s forecast.

JAPAN | GDP hits six-quarter high but apparent strength is deceptive

The economy defied the strength of the yen and global headwinds in Q3, managing to expand a robust 2.2% from the previous quarter in seasonally adjusted annualized terms (SAAR), which represented the fastest acceleration since Q1 2015. When analyzed in more detail, however, Japan’s economic recovery appears to be less robust. Weak wage growth continues to dampen private consumption, while an uncertain global outlook and a strong yen remain a concern for businesses. Economic indicators for October paint a mixed picture of the economy: consumer confidence remains subdued, while healthier external demand is boosting sentiment among manufacturers. In Japan, Donald Trump’s victory in the U.S. presidential election has the potential not only to hit the country’s all-important external sector, but also to further strengthen the yen if global uncertainty rises.

While the Central Bank seems to be running out of ammunition, Prime Minister Shinzo Abe will seek to persuade private companies to boost wages and urge his government to unveil an expansionary budget next year in an attempt to jumpstart growth. However, an uncertain global outlook and the absence of deep economic reforms in the country will keep growth sluggish. Analysts see the economy growing 0.6% this year. Next year, they see growth at 0.8%, which is unchanged from last month's projection.

UNITED KINGDOM | Parliamentary approval for Brexit negotiations needed

Growth in the UK decelerated slightly in Q3, but the slowdown was less than markets had expected. A preliminary set of data shows that economic activity was supported by an acceleration in the service sector, which makes up more than 70% of the economy. This acceleration offset contractions in smaller sectors of the economy such as construction and industry. Despite Q3’s slight deceleration, economic data are holding up well in the UK. The unemployment rate inched down in September and the manufacturing PMI remained in expansionary territory in October. That said, the pound has had a rollercoaster ride this past month. The currency surged at the beginning of November after the High Court decided that the government needs parliamentary approval to start negotiating with the European Union. The decision, if also upheld by the Supreme Court on 5 December, could delay Brexit or force the government towards a softer exit.

Political uncertainty stemming from the referendum will continue to deter investment, but accommodative policy action taken by the BoE will soften the impact next year. Our panel expects the economy to grow 1.9% in 2016 and to decelerate to a 0.9% increase in 2017, which is up 0.2 percentage points from last month’s estimate. 

INFLATION | Global inflation rises on higher commodities prices

Global inflation continued to rise in October and inched up from September’s 3.3% to 3.4%. October’s result marked the highest rate in over two years. Although the increase stemmed mainly from higher commodities prices, the cost of global raw materials remains low, given that most commodities markets remain oversupplied.

Disinflationary pressures are still strong in a number of advanced economies. Against this backdrop, most central banks are implementing largely accommodative monetary policies, which include, in some cases, ultra-low interest rates—even below zero—and quantitative easing programs. The use of such unconventional measures is expected to continue next year and further monetary policy easing is priced in by the markets, apart from for the U.S. The U.S. economy remains the outlier among advanced economies, with most market participants expecting the next rate hike at the FOMC’s monetary policy meeting scheduled for 13–14 December.

Analysts expect global inflation to stabilize towards the end of the year and average 3.4% in 2016, which is down 0.1 percentage points from last month's estimate. Next year, Trump’s economic agenda—if fully implemented—will likely fuel inflation due to fiscal stimulus and higher import tariffs, along with a recovery in commodities prices. That said, a rapid increase in U.S. inflation would cause the Fed to act suddenly and embark on a tightening cycle to combat rising inflation. Analysts predict that global inflation will rise to 4.0% in 2017, which was revised up 0.1 percentage points from last month’s projection.

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Written by: Ricardo Aceves, Senior Economist

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