While we believe the global
economy is sound enough to
continue modest growth, there
are a number of risks to the outlook and
we are watching these closely.
Trade is the greatest threat to disrupt the global economy.
Trade tensions. Historically, real global GDP
growth has been highly correlated to world
trade volume. (Chart 4) Because of the
relationship between global GDP and trade,
we believe the biggest risk to the current
economic backdrop continues to be global
trade tensions. The Trump administration’s
protectionist stance led to tariffs of 25% on
steel and 10% on aluminum imports imposed
on several western allies, including Germany,
France, Canada and Mexico.
The EU responded to the steel and
aluminum tariffs with retaliatory threats of
penalties on U.S. farming and consumer
goods. A puzzlingly contentious G7 summit
in June only inflamed tensions between the
U.S. and its long-time trade partners, most
Chart 4: The correlation between real Global GDP growth and world trade volume
Source: “OECD Total: Real Gross Domestic Product/World Trade Volume,” Organization for Economic Cooperation and Development,
Netherlands Bureau for Economic Policy Analysis/Haver Analytics, June 2018.
The administration on June 15 announced
it intends to impose 25% tariffs on a wide
range of Chinese imports worth about
$34 billion, beginning in July. Potential
duties on an additional $16 billion worth of
imports from China requires public review,
according to the U.S. Trade Representative’s
office announcement on the new tariffs,
which could bring the total to $50 billion.
China swiftly announced its own 25% tariff
on $34 billion of U.S. goods, including
agriculture products, automobiles and
“aquatic products.” These actions escalated
the strain over trade between the world’s
two largest economies and we believe
trade frictions with China will linger in the
near term. However, we think an all-out
trade war still can be avoided, especially
if China were to take conciliatory actions
such as opening its markets to address
its overall trade position with the U.S.
Talks between member nations of the North
American Free Trade Agreement (NAFTA)
have run hot and cold for much of the year.
A deal to revamp NAFTA may be on hold
until 2019. U.S.-Canada relations are
uncharacteristically cool following the latest
G7 meeting and Mexico will hold elections
later this year, during which U.S. relations and
the trade pact could be key campaign issues.
While there is validity over issues like U.S.
intellectual property theft and trade deficits,
the relationship between real GDP and
trade value is highly correlated. We believe
it would be harmful to global growth if the
U.S. continues to impose tariffs on more
goods and more countries.
The Fed will raise interest rates
two more times this year.
Interest rates. Yields on the U.S. 10-year
Treasury bond have risen by more than
0.5 percentage point since the beginning
of the year and a recent move above
3% caused concern that rising interest rates
will slow U.S. economic growth. Typically,
a rise in interest rates first impacts the
housing market. However, data continue to
indicate that housing inventory is too low,
relative to demand. While we could see
temporary dips in demand for housing,
we think demographics are likely to
continue to support housing demand.
The most recent delinquency rates for
consumer debt outside of housing have
begun to rise but are generally still at low
levels. The overall cost for consumers to
service their debts is historically low when
compared to income levels.
Fed Chairman Jay Powell has followed his
predecessor’s practice of telegraphing the
central bank’s intentions well in advance of
its actions to avoid surprising the markets.
This was evident by the hike in interest
rates by 0.25 percentage point in June,
which put the key federal funds in a target
range of 1.75–2.0%. We anticipate the Fed
will make two more rate hikes in 2018.
The markets will see positives in
U.S.-North Korea summit.
Geopolitical ripples. The diplomatic
makeover of North Korea has to be the
story of 2018 so far on the geopolitical
front. In the span of less than a year, Trump
and North Korea’s Kim Jong-un have gone
from hurling insults and threats at each
other via social media to an unprecedented
face-to-face meeting in Singapore in June.
While it’s unclear if North Korea’s nuclear
aspirations have abated, or whether the two
sides can agree on what a denuclearized
Korean peninsula looks like, we think the
summit is a positive first step toward
improved relations and we believe markets
will view it favorably in time.
One area where we could see a possible
halo effect from the Trump-Kim summit is the
U.S. midterm elections, which will garner
considerable attention from the markets as
November approaches. Current polling
suggests the Democrats could win the
majority in the House of Representatives,
but face stiffer competition in the Senate.
However, Republicans would certainly like
to tout a “peace and prosperity” narrative
to help maintain their majorities in both
chambers. Should leadership in both houses
of Congress change hands, we believe talk
of impeachment proceedings will ratchet up,
sending another bout of volatility through
We also are mindful of a couple EU political
dramas. In Italy, the Five Star Movement and
the far-right Lega party won elections in
March and formed a coalition government.
These populist parties are opposed to fiscal
rules established by the EU, which could
lead to conflict going forward. A political
scandal in Spain triggered a no-confidence
vote in its parliament, leading to the ouster
of the country’s prime minister. Pedro
Sanchez of the Spanish Socialist Workers’
Party now leads the government. Finally,
a cronyism scandal is shaking confidence
in Japan’s Prime Minister Shinzo Abe,
although he appears determined to ride
out the political storm.
Emerging markets volatility. Recent
volatility in emerging markets asset prices
has garnered much attention. Eventually,
the increase in emerging markets debt
over the last decade could be a problem
as global liquidity declines on the back of
central banks ending ultra-easy policies.
But the current account positions for many
emerging markets have improved over the
last few years. We believe concerns are
overstated now as problems are more
country-specific. We also think steady
global growth and little inflationary pressure
in emerging markets are likely to allow
those economies to remain strong.
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The opinions expressed are those of Ivy Investment Management Company, are current through June 2018 and are subject to change at any time based on market and other current conditions.
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