Quarterly economic outlook for third quarter 2017
July 11, 2017 | By John Greenwood
- The US business cycle expansion is still intact, owing much more to underlying fundamentals such as private sector deleveraging, the recovery of the banks, improved consumer finances, low inflation, and continuing low interest rates than any impact from the ascension of Mr. Trump to the presidency.
- In my view the US expansion should be able to continue for several more years. This could support further upswings in equities, real estate and other risk assets as expanding GDP is reflected in higher corporate and household earnings.
- The main risk to this scenario is that the Federal Reserve (Fed) tightens credit too sharply, not by raising rates, but by curtailing credit growth in the private sector. This could happen as the Fed shrinks its balance sheet, even if interest rates remain very low.
- Following the 0.25% hike in the US federal funds rate in June, I expect the Fed will raise interest rates once more in 2017, by 0.25%. I also expect the Fed to start shrinking its balance sheet in October or November.
- In my view, US consumer price inflation will soften in the short term and rise only moderately in the medium term without much impact from the tightening labor market or any expansion of the federal deficit. The reason is that money and credit growth remain subdued at around 4% to 6%.
- In the eurozone, growth has improved and the hurdle of political elections has passed without threat to the euro currency system. The German elections in September are the remaining uncertainty, but there is no serious populist threat to the established parties of center right or center left.
- The triggering of Article 50 on March 29 for Brexit will lead to protracted negotiations between Britain and the EU over the next two years. During that period I expect any progress or setbacks in the discussions to be directly reflected in sterling and gilt yields, which will inevitably be volatile.
- Imported inflation from the depreciation of sterling has reduced UK consumer spending in real terms, while the overall uncertainty about the exit process will likely undermine foreign direct investment (FDI) in the country.
- The general election called by Prime Minister Theresa May on June 8 produced a “hung parliament” with Conservatives having to ensure their survival by doing a deal with the Democratic Unionists of Northern Ireland. This outcome has greatly reduced Prime Minister May’s freedom of action across a range of policy areas.
- Meantime, the Bank of England’s (BOE) credit promotion policies implemented last August risk adding domestically generated inflation to imported inflation from the weak sterling. The BOE responded by tightening capital requirements on June 27.
- The Japanese economy has seen slightly better growth, but inflation remains far below 2%. The combined policies of Prime Minister Shinzo Abe and Governor Haruhiko Kuroda at the Bank of Japan are missing their targets.
Source: Macrobond, as of June 28, 2017
- China has continued to alternate between squeezing and easing credit with the aim of keeping the economy on the rails ahead of the fall National Congress. External trade figures have improved slightly, but this does not mark the start of a renewed export-led boom. Overcapacity in basic industries such as coal and steel and rising nonperforming loans in the banking system are constraining the growth of new investment.
- On the external side the Chinese authorities have been restricting capital outflows and attempting to encourage more inflows, enabling the currency to stabilize in recent months.
- In the commodity complex, oil prices remain under downward pressure thanks largely to the developments in US shale and the difficulty of maintaining the OPEC cartel under current conditions. The majority of base metal prices increased in anticipation of a strong Trump infrastructure program, but the failure of those plans to materialize has meant that the rally has stalled. As such, the upside for commodities in 2017 is undermined, in my view.