2017 can be characterized as a year that should be celebrated. The world’s economy enjoyed synchronized global growth, with all major developed economies reporting positive GDP growth. The Eurozone reported 2.3 percent real GDP growth, Japan nearly doubled its GDP from the year prior, while emerging markets managed to make quite a comeback. The forecasts for 2018 were also very optimistic with the International Monetary Fund initially estimating 3.9 percent global growth. Although the IMF subsequently revised its forecast down to 3.8 percent, it is still anticipating synchronized growth across nations. Disappointingly, Q1 data was not very supportive of this optimistic view.
With both the Eurozone and the U.K. decelerating, and Japan falling into negative territory, economic growth for 2018 does not look as promising. Emerging markets have been hit the hardest, a direct result of rising U.S. rates and a strengthening U.S. dollar. With almost 80 percent of emerging market debt denominated in U.S. dollars, the region has come under significant pressure. Capital outflows only serve to exacerbate the problem, further strengthening the U.S. dollar and leading to even greater outflows and increased economic weakness.
Policymakers described the first quarter GDP weakness as a temporary soft spot, attributed to severe weather conditions and other temporary factors. However, recent economic data suggests that hopes of a strong rebound in growth in Q2 may not materialize.
Surveys of purchasing managers across the globe indicate lower overall growth. Recent retail sales, property sales and fixed investment in China are all declining, suggesting the world’s second largest economy is also slowing. Lower global trade figures provide further evidence of less economic activity overall, and particularly in emerging markets.
Heightened geopolitical risks only add to the uncertainty of the positive global growth story. Trade tensions between China and the U.S., despite recent agreements, continue to simmer below the surface. China agreed to increase agricultural and energy imports from the U.S., in addition to reducing import tariffs on vehicles, in response to President Trump softening his stance on $150 billion in import taxes on Chinese goods. Although an all-out trade war seems to have been avoided at the moment, the agreement does not solve the U.S. president’s campaign promise to reduce the bilateral trade deficit. Therefore, a resurgence of trade tensions is highly likely.
Other geopolitical issues, including the Iran deal, tension between North Korea and the U.S., as well as the Italian elections only add to the general market uncertainty.
The U.S. story is undoubtedly very different as the world’s largest economy is much better positioned than its peers. Economic growth prospects for the U.S. remain buoyant, supported by the lagging effects of the 2017 tax cuts and fiscal stimulus package. Furthermore, leading economic indicators suggest that this position of relative outperformance will continue for some time. The attractive U.S. growth rate has resulted in increased interest rate differentials between the U.S. and its counterparts, bolstering the greenback. If the Fed increases rates at a faster pace than currently expected by markets and if the U.S. continues to outperform its counterparts, the dollar could strengthen even further.
Notwithstanding economic weakness in the first quarter of the year and the myriad challenges ahead, global output is expected to hold up for this year. Second quarter data will be of great importance in assessing the validity of current consensus forecasts. While recent weakness does not necessarily confirm an impending slowdown in 2018, it does require diligence on the part of the investors as risks to growth forecasts have increased to some degree.
Sources: Bloomberg LP, BCA Research, Capital Economics
Disclaimer: The views expressed are the opinions of the writer and, while believed reliable, may differ from the views of Butterfield Bank (Cayman) Limited. The Bank accepts no liability for errors or actions taken on the basis of this information.