Global macro
In the US, we believe peak levels of growth are behind us, although we expect annual growth of around 2.75% to persist through the first half of 2019 before slowing. Fiscal stimulus is still having a positive effect on growth, but will likely wane in the second half of 2019. In addition, the positive financial tailwinds that have been driving the economy may turn more neutral as monetary policy continues to tighten. Therefore, while consumer spending will likely be additive to growth in the first half, as the boost from tax cuts winds down, the question is how much will the consumer want to spend thereafter? Consumption has grown at an unsustainably high level, in our view, over the last several quarters, driven by stronger consumer confidence and tax cuts. A meaningful slowdown in consumption could have negative implications for broader growth. These effects mean that risks to economic growth are higher in late 2019 than they have been in previous points in the cycle.
Inflation is likely to increase somewhat in 2019, supported by tariffs on goods prices. Aside from tariff-driven inflation, pressures are likely to be more subdued. However, labor prices are likely to continue their slow rise as employment markets tighten. We do not believe that wage inflation will be significantly passed through to consumer prices in 2019.
The combination of strong labor markets and strong growth make it very likely that the US Federal Reserve (Fed) will continue its slow hiking cycle through the first half of 2019. However, if the yield curve continues to flatten and financial conditions tighten, it might be more difficult for the Fed to hike twice in the second half of 2019.
The US Treasury market has undergone a significant correction, and valuations are now inexpensive relative to long-term fundamentals, in our view. However, large fiscal deficits will continue to cause the US Treasury to issue large amounts of debt. Increased supply combined with declining Fed purchases could create US Treasury volatility in the coming year. US growth is attracting capital flows, and this is likely to continue until global growth paths begin to converge. In our view, this is likely to support the US dollar in the coming months. If there is a significant US slowdown next year, we believe it would likely be imported from China (not generated internally), if China is unable to ease itself out of the slowdown it is currently experiencing.
Outside the US, there are also signs of softening growth. In China, we have been penciling in lower-than-consensus 2018 economic growth since the start of the year. The current softness in economic momentum may be traced back to tightening regulations and deleveraging policies that took place in late 2017/early 2018, leading to a sharp slowdown in credit trends in mid-2018. Additional uncertainty has been generated by US trade policy. Chinese policymakers have begun to ease again in response to these developments in growth. The success or failure of this easing program will likely have major implications for global financial markets.
Europe is proceeding at a slower pace than we expected earlier in the year, as the effects of stimulus delivered in 2015 and 2016 fade. In addition, several risk events on the horizon are likely to act as headwinds to both growth and markets: Italian politics and budget concerns, US-Europe trade tensions and Brexit uncertainty. On top of that, the European Central Bank is likely to begin its hiking cycle sometime in the fourth quarter of 2019. Due to these growth and political factors, we do not expect core European interest rates to move too far from current levels in the next six months.