RISK MANAGEMENT

The Next Six Months: Where Are the US, Europe, China and Japan Headed?

Global economic activity has generally been good during the first six months of 2017. Europe’s renewed momentum has been a highlight for the developed world, and China’s steady growth has compensated for faltering elsewhere in emerging markets.

The balance of the year promises to be intriguing, however. Brexit negotiations are under way, and the British economy is on tenterhooks. The US Congress is debating tax policy with a debt ceiling deadline looming. Oil prices are in retreat, challenging the finances of many producers.

And China will be holding a key party meeting in the early fall that will set an important tone for economic policy.

The eurozone has weathered the worst of populism and its economic recovery is gaining strength

Following are our views on how key markets are positioned as we move into the third quarter.

United States

The fundamentals of the US economy have provided the Federal Reserve with ample confidence to raise the policy rate three times within a span of seven months. The central bank also announced its plans to commence balance sheet reduction soon, but it did not provide the timeline for this program.

The labor market is the strongest sector of the economy. The latest civilian unemployment rate (4.3%) is well below most estimates of full employment. Other measures of labor market performance are back to levels last seen in 2007.

While the absence of acceleration in employment compensation at the current stage of the business cycle remains a bit of a puzzle, sustained economic growth should result in wage pressures in the quarters ahead.

Business and consumer spending are both expected to advance during the rest of the year. The housing sector presents a mixed picture: home sales and construction have been sluggish, but favorable employment conditions are expected to support housing going forward.

The current administration’s plans for a fiscal boost are unlikely to be implemented soon, if ever. Our US forecast continues to assume little in the way of movement on tax reform or infrastructure spending.

Inflation remains below the Federal Reserve’s target, largely due to declines in prices of medical care commodities and telephone services. Slightly higher inflation readings are likely in the quarters ahead, given the projected forward business momentum.

Eurozone

Emmanuel Macron’s victory in the French Presidential elections, the recent setbacks to Italian populist Five Star Movement and a string of positive economic surprises have created a complete turnaround in sentiment surrounding the eurozone over the last few months.

While some were concerned about the gap between hard and soft economic data earlier in the year, recent upward revisions in official figures have helped close that gap. Overall, we expect real gross domestic product (GDP) in the eurozone to grow at 1.9% in 2017 and unemployment to fall to 9.1% by the end of this year.

Risks are tilted to the upside.

Inflation has exceeded expectations since late 2016, but it has been largely an oil story and therefore transitory. The recent stability in oil prices and strength of the euro, along with ample spare capacity — both material and labor — should keep a lid on price pressures.

We expect eurozone-wide headline inflation to soften from its recent highs and average 1.6% for the full year.

The European Central Bank (ECB) will be faced with a tough communication challenge over the next year. Improving growth has weakened the case for continuation of extraordinary monetary policy measures, but inflation is expected to remain below 2% for the next few years. 

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