Degoof: Central banks confirming message

While current tariffs remain modest, the risk for subsequent tit-for-tat increases is high. Even though some leading indicators suggest that the pace of the recovery is slowing, the world economy remains robust for the time being. The negative output gaps witnessed over the past decade in most parts of the world have all but closed so that the momentum for catch-up growth is quickly fading. Tighter monetary conditions, a gradually diminishing effect of US fiscal stimulus measures, capping commodity prices, a more difficult international trade environment and less Chinese capital investment signal a growth slowdown in the quarters ahead. Indeed, we seem to be in the late-cycle phase of the expansion. The only thing missing is a general pick-up in inflation. So far, firming economic activity has only modestly translated into rising wage and inflation readings. Headline inflation has been creeping higher but this is mainly the result of the year-on-year evolution in energy prices. Core inflation, meanwhile, remains quite modest. There has been a lot of talk about the death of the Phillips curve but it might be premature to confirm that message. All in all, inflationary pressures are slowly but gradually building. At the same time, other factors including globalization, technological change and digitization, the ageing of the population, insufficient labour union power, lower anchored inflation expectations and sluggish productivity growth suggest that inflation is unlikely to break out. Financial conditions look set to become tighter from here eventually biting into economic activity, perhaps already later this year. Central banks are focusing on gradually removing monetary accommodation, following the tightening cycle of the Fed.

US: sustained growth reassuring Fed

The United States are currently seeing the second-longest economic expansion in history with second quarter growth coming in at over 4% annualized. Meanwhile, the yield curve continues its flattening trend. This is something to monitor closely as it tends to go hand in hand with slower economic growth further down the road. That said, recession odds are still low for now. Consumer confidence is still strong and the outlook for investment has been improving according to several leading indicators. Importantly, the low household savings rate in combination with an expensive equity market and rising real estate prices bear watching. President Trump’s tax reforms are temporarily boosting economic growth but will primarily result in deteriorating public finances (towards a deficit of around 4 to 5% of GDP) and growing inequality over time. Inflation is rearing its head again, albeit still modestly, as the labour market is nearing full employment. During its latest meeting the FOMC left the funds rate unchanged. But the strong momentum in the economy means that more tightening of monetary policy is in the cards. As things currently stand it can be expected that the Fed is looking to hike rates again next month. If no negative economic surprises emerge, another rate hike is expected in December. In case significant volatility in financial markets resurfaces, it may convince the Fed to be more cautious. Further significant flattening of the yield curve over the coming months could well prompt the Fed to pause its monetary tightening efforts at some point in 2019 when the pace of economic growth is likely to slow down materially. The economic impact from tariffs on Chinese imports remain negligible for now but a global trade war and equity slump would be costly. […]

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