Monaem Sarker :
The trade war between the United States and its trading partners have created a number of downside risks for the global economy. So how is the global economy faring? How will the retaliatory tariffs imposed by the United States and China, among others, affect the global economy? These are questions that have been raised in recent policy discussions around the globe.
The U.S. economy is on course to post another strong showing in 2018. U.S. real Gross Domestic Product (GDP) grew at a 4.1% pace during the second quarter. The underlying details were even stronger than the headline number, with real final sales surging as inventories were drawn down sharply. While there is doubt that there will be another 4% GDP number in coming quarters, the economy clearly has strong momentum going into the second half of the year. Part of the second quarter’s strength came from efforts to produce and ship products ahead of retaliatory tariffs. The inventory drawdown pulled production forward and left inventories exceptionally lean throughout the supply chain. Despite a fading boost from fiscal stimulus and rising short-term interest rates, rebuilding inventories should keep output growing at around a 3% pace in the second half of 2018.
Stronger economic growth will keep the Federal Reserve Bank on its current course of gradually raising the interest rate. We expect quarter point hikes in federal funds rate in September and December, respectively. The US economy appears well positioned to absorb further increases in interest rates.
As the U.S. economy hums along nicely, other economies are not faring so well. Real GDP growth in the Eurozone slowed modestly in the second quarter at 2.1%. The eurozone entered 2018 on a high, having racked up its most rapid expansion in a decade during 2017. But growth slowed sharply in the first three months of this year, a setback that can be partially attributed to unusually cold weather and labor strikes in Germany and France. The failure of the economy to rebound in the second quarter shows other forces may be at work. We expect to see this divergence in economic growth between the U.S. and others continue the rest of 2018.
Inflation in the Eurozone is still largely benign. Although headline inflation has picked up to reach the European Central Bank’s (ECB) 2% target in recent months, core inflation still remains steady around 1% and has restrained the more rapid removal of policy accommodation on the part of the ECB. That said, the ECB plans to end its quantitative easing program at the end of this year. Assuming economic growth and inflation continue to pick up, we then look for the ECB to begin raising interest rates in mid-2019.
Trade tensions in the Eurozone heated up in the second quarter of 2018 as the Trump administration threatened a 25% tariff on auto imports from the European Union (EU). A recent Washington, D.C. summit has since calmed the nerves of trade watchers as the EU and US agreed to work toward removing trade barriers. However, the situation could deteriorate again if negotiations were to reach an impasse.
A full blown trade war, should one come to pass, probably would not completely derail the Eurozone economy. Exports to the United States totaled just 2.5% of Eurozone GDP in 2017, meaning that the effect from tariffs could be painful, but not large enough to meaningfully drag on the overall economy. Although trade tensions present a downside risk, we look for the economic expansion to remain in place, and forecast that real GDP will grow roughly 2% in 2018.
The U.S. dollar’s continued rise is injecting further risk into emerging markets, particularly those which have been borrowing heavily in the U.S. currency and benefiting from foreign investment, such as, Turkey, Hungary, Argentina, Poland, and Chile. Countries with large U.S. currency debts and big foreign capital flows are at risk as the U.S. dollar climbs.
(To be continued)
