2018 Midyear global outlook:
What are the risks?

06.28.18

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.

IVY VIEW
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 notably Canada.

Chart 4: The correlation between real Global GDP growth and world trade volume
Chart Showing 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.

IVY VIEW
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.

IVY VIEW
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 the markets.

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.

2018 Midyear Global Outlook - Continue Reading
Section 1 — U.S. economy sets the pace
Section 2 — Global economy hums along
Section 3 — U.S. dollar rally looks more durable
Section 4 — What are the risks?
Section 5 — Key sectors to watch


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