Goldman Sachs 2019 Outlook: Landing the Plane

  • The global economy looks poised to slow moderately from 3.8% in 2018 to 3.5% in 2019, led by deceleration in the US and further softening in China. But with growth still above potential in most DM economies, we look for continued labor market tightening, gradually rising core inflation, and in many cases higher policy rates
  • Our Fed call remains hawkish relative to the market, with five more 25bp hikes to a terminal 3¼-3½% funds rate at the end of 2019. While higher rates and tighter financial conditions should help slow growth to its potential rate over the next year, we expect a decline in the unemployment rate to 3% and a rise in core inflation to 2¼% by early 2020
  • We think concerns about the global impact of tighter Fed policy are overdone. Spillovers to EM are real, but the market has already priced 11 of the 13 hikes we expect for this cycle, so most of the adjustment to more normal US interest rates is probably behind us. The main risk to this view is a more substantial US overheating that eventually forces steeper rate hikes.
  • China has slowed quite sharply in 2018, on the back of slower credit growth and fears about a more damaging trade war. With monetary and fiscal policy now in easing mode, we expect only a modest further deceleration. The macro impact of increasing tariffs is also likely to remain manageable, even under our call for some further escalation in early 2019
  • Although growth in Europe and Japan has decelerated in the course of 2018, it remains above trend. This should put further downward pressure on the unemployment rate and keep the recent upward trend in wage growth intact. However, with core inflation still far below the target, the Italian budget crisis unresolved, and Brexit negotiations ongoing, the risks to our forecasts of a first hike in the ECB deposit rate in Q4 2019 are tilted to the later side
  • Beyond 2019, the risk of a global recession is likely to rise as more and more DM economies move beyond full employment. However, even in subsequent years recession is not our base case. Financial imbalances still look very limited, and the flatter and more anchored Phillips curve has reduced the need for central banks to reverse an overshooting of full employment quickly.
  • Tight labor market is increasingly translating into higher wages and prices. Wage growth is now up to about 3% y-o-y across a range of measures, with wage survey indicators pointing toward further gains. While sequential core PCE price inflation has been a bit softer than expected recently, the y-o-y rate remains at 2% at a time when the tariff impact is probably just about to show up in higher goods pricing. We continue to expect a gradual move to about 2.25% by end of 2019. This implies that growth needs to slow to its estimated trend pace of 1.75% sooner rather than later, from a recent pace of around 3.5%
  • We find that Fed policy shocks do not have significant net effects on financial conditions in foreign advanced economies. This is because the exchange rate tends to cushion spillovers into long-term interest rates and equity prices in other DMs. We do find that hawkish Fed shocks have net negative effects on EM financial conditions because exchange rates do not move sufficiently to offset the spillovers into EM domestic financial conditions. Hawkish Fed is therefore, in principle, a concern for EM
  • China has slowed significantly in 2018; credit growth slowed sharply in the early part of the year, which tightened financial conditions and slowed domestic demand growth; fears about a damaging trade war with the US weighed on Chinese sentiment and equity prices
  • PBoC has already lowered short-term interest rates from 3% to 2% this year, the Renminbi has depreciated 6.5% against the dollar, credit growth has picked up sequentially, and fiscal policy has turned more expansionary since the summer; authorities have signaled that policy will be eased further as needed and we expect additional fiscal measures in coming months, with corporate tax cuts and increased bond issuance to finance local infrastructure projects
  • Analysis suggests that tariffs on China should have a moderately negative effect on Chinese growth; real GDP hit of 0.25% under our baseline expectation and 0.4% if Trump raises the tariff rate on the remaining $267bn to 25%
  • Cutting through the noise, underlying growth trend in the Euro area has slowed from about 3% at the start of the year to just below 2% now
  • European economy faces a range of risks in 2019 that could make the outcome worse than we expect; Italy’s budget crisis remains unresolved and we expect the Italian economy to flirt with recession early next year; a disorderly Brexit also remains a risk but parliamentary ratification before March 2019 remains our base case; US auto tariffs still cloud the European outlook but we expect the US administration to focus trade restrictions on China
  • Baseline forecast remains for the first hike in the deposit rate (ECB) in late 2019
  • Next year will be a challenging one for Japanese growth, mainly because we expect the planned October VAT hike to weigh sharply on growth in 2019 Q4; government will likely try to cushion the impact by recycling some of the additional revenue via spending hikes, but we nevertheless expect a drop in GDP
  • For 2019, risk of recession looks low; growth momentum remains fairly strong, financial conditions are broadly accommodative, debt growth remains subdued, inflation is moderate, and output has not yet meaningfully surpassed its potential

Goldman Sachs 2019 Outlook: Landing the Plane, November 14, 2018

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