All is well in the world economy. That's the picture that emerges if you glance at our latest economic growth forecasts. The recovery has finally spread to pretty much all corners of the world. Particularly in the Eurozone, key indicators appear to be going from strength to strength, leading us to raise our estimates for growth in gross domestic product (GDP) to 2.1% for 2017 and 1.8% for 2018. For China too, we have slightly raised our estimates to 6.7% and 6.5%, respectively. Even Japan, the perennial laggard, is finally showing signs of economic life. We have increased our estimate for Japanese economic growth to 1.5% for 2017, though we continue to doubt it will speed up even further in 2018.
Meanwhile, the U.S. economy is close to full employment, steadily growing at around 2.2%. Labor costs are slowly edging upward. This is consistent with the U.S. Federal Reserve (Fed) continuing to take its time in raising interest rates and beginning to gradually shrink its balance sheet. We expect two more rate hikes during the next 12 months. All in all, it sounds like the sort of global economic backdrop financial markets have come to love. Take a step back, however, and a slightly fuzzier picture emerges. Our forecasts are surrounded by unusually large bands of uncertainty. The reasons why can be readily explained through the following thought experiment.
Imagine that two years ago, you had fallen into a coma. Fortunately, you are now recovering. A large pile of newspapers is sitting at your bedside table. Naturally, you start out with the financial pages. You are reassured to discover that markets have been stronger than you would have dared to hope back in October 2015.
In terms of the underlying economics, one recent statistic particularly catches your eye: unemployment is finally falling across the Eurozone; in Germany, it is now at the lowest level since re-unification. Quantitative easing (QE), it would seem, has been just as effective in boosting asset prices in the Eurozone as it had been in the U.S. Deflation, let alone a break-up of the common currency, no longer appears to be much of an issue.
Then you turn to the politics pages. For the first time since World War II, a hard-right party has won seats in the lower house of the German parliament, with almost 13% of the vote. In Catalonia, a referendum of dubious legality has led to violent scenes you would not have expected in any Western European democracy. You are stunned to read that the United Kingdom has voted to leave the European Union – and that its weakened government still appears to have no clear plan of what sort of Brexit it is aiming for. Tensions are growing on the Korean peninsula.
On the other side of the Pacific, Donald Trump has been elected U.S. president, with no discernable change in his Twitter antics. A year on, many questions remain open, starting with what sort of chairman Trump might pick for the Fed. Meanwhile, Japan is having a snap election, pitting an opposition in disarray against an increasingly unpopular government. Earlier in the year in France, the traditional parties of the center-right and center-left saw their vote share collapse. Encouragingly, the new French president Emmanuel Macron is finally tackling labor-market reforms.
All told, you appear to have woken up to an age of political upheaval that stands in striking contrast with the reassuring picture in the economic and financial data. This, we would argue, is no coincidence. Modest wage growth in much of the developed world, for example, has probably contributed both to inflation remaining subdued and to voter dissatisfaction with the status quo. With the possible exception of Brexit, there are few signs of political instability spilling over to economic decision-making.
For the next 12 months, recession risks continue to appear low in all major economies. However, the political economy is clearly shifting, and not necessarily in ways conducive to global growth and financial markets. The fight over U.S. tax reform might prove an important test case in this regard, particularly as it relates to corporate tax rates. We continue to expect modest cuts to be passed – but with plenty of uncertainty in both directions.
The U.S. labor market continues to improve, but at a slower pace. It may now be approaching full employment.
Source: U.S. Bureau of Labor Statistics; as of 8/1/17
On most measures, U.S. wage growth has only risen slightly. It looks set to remain gradual, not least due to subdued inflation expectations.
Sources: U.S. Bureau of Labor Statistics, U.S. Federal Reserve; as of 9/1/17