Barring a zombie apocalypse or a sudden spontaneous collapse in asset prices, the current Goldilocks environment of synchronized, above-trend global economic growth and low but gently rising inflation will likely persist in 2018.
That said, the conclusion from PIMCO’s latest Cyclical Forum is that 2017–2018 could well mark the peak for economic growth in this cycle and that investors should start preparing for several key risks that lie ahead in 2018 and beyond.
We discuss our 2018 outlook and investment implications in detail in our recent Cyclical Outlook, “Peak Growth.”
Global expansion continues
Recent growth momentum has been even better than expected across many economies, providing a strong ramp into 2018. Moreover, easier financial conditions (reflecting buoyant markets for risk assets and still-low interest rates) imply sustained near-term tailwinds, and fiscal stimulus in the U.S. and elsewhere in the advanced economies is forthcoming. Meanwhile, China keeps suppressing domestic economic and financial volatility while fundamentals in many other emerging market economies continue to improve. Taken together, PIMCO’s baseline forecast is for world real GDP growth in a 3% to 3.5% channel in 2018.
However, a Goldilocks-extended scenario is very much baked into the consensus and asset prices. During our December Cyclical Forum we expressed confidence in our baseline economic prognosis, and we zoomed in on the potential shorter- and longer-term consequences of synchronized global growth, fiscal stimulus in the U.S. at a time of already high resource utilization and the reduction of monetary accommodation by major central banks.
Specifically, we’re watching three key developments:
Borrowing from the future
First, the prospective U.S. fiscal expansion in 2018 appears dictated by the political cycle rather than the economic cycle. Fulfilling 2016’s presidential election campaign promises and delivering tax cuts and spending increases ahead of 2018’s congressional midterm elections makes political sense but could have detrimental longer-term economic consequences. Why?
Arguably, the last thing an economy operating at close to full employment in the ninth year of an economic expansion needs is a shot in the arm from fiscal policy. Adding around $1 trillion to the public debt over 10 years without adding much to potential growth and thus future tax revenues could come back to haunt the public coffers if rates rise in the future. And most importantly, depleting the fiscal toolkit while the economy is good comes at a price: Higher fiscal deficits and debt levels imply that the room for fiscal stimulus in the next recession will be more limited.
Cyclical pressures could push inflation higher
A second major risk related to the 2018 outlook is that wage and/or price inflation may finally inflect higher as employment overshoots its natural level.
There are good reasons why this hasn’t happened so far, including low productivity growth, the recent rise in labor force participation and diminished bargaining power.
However, the risks of a cyclical inflation overshoot in 2018 are rising given the globally synchronized nature of the expansion, additional fiscal stimulus, recent rises in commodity prices and super-easy financial conditions. Global structural forces are still weighing down inflation, but the cyclical pressures are clearly on the up.
The risk of monetary overkill
A third risk for 2018 is that the reduction of monetary accommodation – well-intentioned as it may be given decent cyclical growth – turns out to be too onerous for economies and asset markets that have become addicted to low short rates and depressed term premia across the yield curve.
The turn in the tide of global central bank policies poses significant risks to markets and economies, particularly as the new and still-evolving Fed leadership is untested.
Read PIMCO’s latest Cyclical Outlook, “Peak Growth,” for further insights into the 2018 outlook for the global economy along with takeaways for investors.
Joachim Fels is PIMCO’s global economic advisor and a regular contributor to the PIMCO Blog.