The global economy looks set to continue its steady post-crisis recovery in 2017, with real growth remaining in the 3-3.5% range for the sixth consecutive year. The good news is that the recovery is broadening, with all of the 20 largest economies expected to grow for the first time since 2010. Still, in Europe and the US, political developments add an unusually high level of uncertainty to the outlook. In the emerging world, China is the wildcard. Although Chinese growth remained resilient in 2016, the threats of a financial accident or a significant loss of macro momentum will be hard to dispel until structural tensions have eased. That will probably be a multi-year story.
Chart 1: Global growth remains range-bound
Source: Bloomberg, International Monetary Fund (IMF) data from 2013 to 2016. 2017 is the consensus forecast. GDP = gross domestic product; real GDP is that adjusted for price changes (ie, inflation or deflation).
While the trend in global growth remains fairly steady, inflation in the major economies is making a v-shaped rebound. Consensus forecasts predict that inflation in the developed economies should reach 2% this year for the first time since 2012. A key reason for the improving outlook is the stabilisation of commodity prices, which have been depressing headline inflation (which includes food and energy) for the last couple of years. The return of inflation to more normal levels in 2017 will boost nominal growth (that unadjusted for inflation) and corporate earnings. It may also erode support for the ‘secular stagnation’ (prolonged slow growth) narrative that has been widely embraced of late. Furthermore, while underlying inflation remains subdued in the eurozone and Japan, wages and prices are recovering more broadly in the US, which means that any further inflation surprises there will probably put upwards pressure on interest rate expectations.
Chart 2: Inflation – back to normal
Source: Bloomberg, data from 2000 to 2015 from the Organisation for Economic Co-operation and Development (OECD). 2016 to 2018 are consensus forecasts. CPI = consumer price index inflation. YoY = year-on-year.
A new era of elevated political risk
Most of the current generation of investors have been exposed to significant market setbacks resulting from economic and financial crises during their careers, but few will have experienced anything like the politically-driven market turbulence of 2016. Unfortunately, the balance of evidence suggests that last year’s events mark the beginning of a new era of elevated political risk. Event risk is high in 2017 – if things go badly we might well find ourselves in the most volatile political risk environment for decades. The known unknowns for this year are: the new US administration, ‘Brexit’ negotiations, and elections in France, Germany, and possibly Italy. Beyond these, a number of more general and potentially troubling political dynamics are evolving in the developed world. Forces such as the rise in populism and nationalism and a backlash against globalisation are prompting growing support for protectionist policy and immigration controls. In the emerging world, uncertainty surrounding China’s future relationship with the US, Russia’s strategic ambitions, and the ever-fragile state of the Middle East all loom over the medium-term outlook.
With regards to ‘Brexit’, the initial focus will be on whether the courts will impede the government’s desire to trigger Article 50 in during the first quarter of the year. Delays are certainly possible. Beyond this, lies the major question of how the government will prioritise conflicting objectives in the negotiations. While domestic political pressures argue for a fast, clean Brexit prioritising immigration-control, economic stability considerations argue for a focus on single-market access and a transitional arrangement to smooth the European Union (EU) exit. Of course, the UK’s stance is only the start of the negotiation process – the ultimate outcome will be largely determined by whatever new relationship the EU offers up. This will probably only emerge after the UK has triggered Article 50 and is likely to be forged in a blaze of threats, recriminations, and brinkmanship. It seems highly probable that market concerns about the political or economic implications of Brexit will flare up significantly again at some stage in 2017.
On balance, the big picture is one of an ongoing global recovery that will face the persistent threat of being derailed by politics. Still, while we do seem to have moved into a world in which previously unimaginable geopolitical outcomes are now conceivable, it is far from inevitable that the worst case scenarios will materialise, nor is it obvious that politics will overwhelm the recovery. Even 2016’s political eruptions did not have a lasting impact on economic growth. Indeed, one growth-positive theme worth noting is that governments tend to ease fiscal policy when anti-establishment movements gather momentum. This has already begun to happen in the UK and parts of Europe and will materialise more dramatically in the US soon, if Donald Trump gets his way.