What are the questions?

The Economic Outlook by Philippe Waechter (Chief Economist of Natixis)

Will global growth accelerate in 2017? In 2016, the global economy was characterised by moderate dynamics. Global growth slowed down and global trade remained on a very low growth trend (+0.8% in volume in September 2016 over one year, compared to 7% on average over the 20 years before the 2007 crisis). Doubt remains for 2017 regarding the source of momentum which will enable the global economy to change tempo. China and the US, even after Trump, will contribute only modestly and insufficiently to durably influence the global growth trend.

What will be the growth rate in detail? The dynamics of the global economy will diverge in 2017 due to the very probable stimulus policy implemented in the US. The Chinese economy has stabilised, as the authorities have taken the necessary steps, but the economy is still in a transition phase towards a service economy. Europe will return mixed performances due to the probable implementation of the Brexit. The UK will be weighed down, whereas the eurozone should maintain its current rate. Among the emerging markets, Asia is the region experiencing the most dynamic growth.

What could happen in the US? The programme presented by the President-Elect, in agreement with the Republican majority in Congress, initially involves significant durable tax cuts. This will improve household revenues and corporate earnings, particularly among domestic companies. It will also be a key factor towards the improvement, at least temporarily, of the US growth profile. Further spending will be introduced at a later date.

Will this shield the US from the risk of secular stagnation? Since the recovery during the 2nd quarter of 2009, US growth has been much weaker than in the past. Furthermore, 7 years after the beginning of the cycle, inflation remains weak due to the lack of tensions within the means of production and in the jobs market. This reflects a net slowdown in productivity and employment dynamics which are not as robust as in the past. The downturn in productivity reflects insufficient investment. The conditions therefore need to be created for a stronger accumulation of capital. This is required to shield the economy from the risk of secular stagnation. The infrastructure investment programme (USD 1,000 billion over 10 years) could contribute however and incite greater private investment.

Will this momentum spill over to the rest of the world? There is always a lag between an improvement in economic climate in the US and the momentum spilling over to the rest of the world. If the programme is limited to tax cuts, it will only have a muted impact over the longer term and will be more readily discernible in 2018 than in 2017. Further measures are required in the US for its impetus to roll over to the rest of the world and have a lastingly positive effect.

How will the eurozone trend? Growth has stabilised in most countries. The risk of a sudden downturn appears limited. In the short term, surveys for November and especially December have given stronger signals regarding economic activity, particularly in the manufacturing sector. This may lead to faster growth as countries in the eurozone trade heavily together. This will be the factor to watch during Q1: will the surveys continue to send out bullish signals? This may be the positive surprise in early 2017. Such a scenario was observed at the end of the 80s and 90s. It may then lead to growth edging towards 2% in 2017. This is not yet the case, but may become so during the first quarter of 2017.

Will the ECB have an important role to play in the dynamics of the economic climate? Yes of course, as Mario Draghi affirmed at the 8 December meeting. He wishes to avoid at all costs weighing on economic anticipations. This is why the quantitative easing programme was extended until December 2017 and that there is no question of tapering. The ECB has simply moved the cursor, but has not changed its message. QE will be extended if the long term inflation outlook does not converge towards 2%.

Exactly, what is to be expected in terms of inflation? Since the summer, inflation has been increasing among industrialised countries. This reflects a stabilisation in the oil price since August, at the level observed at the same period in 2015. As such, the energy contribution to the inflation rate is now converging to zero (having previously been negative and dragging inflation into negative territory) and the inflation rate is converging towards the core inflation rate. Core inflation in the eurozone is around 0.7-0.8%. In the short term (Q1 2017), the contribution will turn positive, as the oil price will be much higher than in Q1 2016 (below 30 dollars at the time). This should lead to a temporary rise in inflation towards 1.5-2% in the eurozone. After that, the inflation rate will converge towards the core inflation rate. I do not believe that the oil price will continue to rise even after the agreement.

What will the Fed do? For several months now, the Fed has been searching for some leeway in its monetary policy management. This was the cause of the base rate hike in December 2015, and also for the hike in December 2016. Private domestic demand will be boosted by the tax cuts in the US. The balance in economic policies will no longer be systematically biased towards monetary policy. As such, the Fed may hike its base rates in order to gain some further leeway.

Will US rates steepen across all maturities? Yes certainly. This will reflect the normalisation of the balance between economic policies. The eurozone is not yet in this situation, as fiscal policies remain neutral.

Will rates steepen durably? Yes, if US growth is sustainable. For this reason a great deal of attention has to be paid regarding the measures which will be taken in the US. If the budgetary impact is not maintained, the US economy will remain under the threat of secular stagnation and interest rates will remain close to the levels observed in 2016.

And the ECB? As I have pointed out, the ECB wishes to maintain a very low interest rate environment and will ensure that this is the case. This means that the yield spread with the US will widen and that the euro will weaken as a result (falling rapidly below parity). The dollar will remain durably strong and not only against the euro.

Does this mean that monetary policies will diverge? Yes. This will be an important factor.

What are the risks in the eurozone? Political risks may offset the improvements observed in the economy. Elections are due in France and the Netherlands in spring and in Germany in autumn. The political situation may polarise excessively, particularly after the Berlin terrorist attack and the election of Donald Trump.

What are the risks associated with China? The major risk is debt, which has surged since 2009. The heavier debt burden is incurred mainly by companies. Gearing among non-financial players is now at the same level as in the US, but without an institutional structure as robust. The economy is shifting towards services and many industrial companies will shut down. When this occurs, the debt will weigh on the banking sector.

Is there a strong risk from the Chinese property market? Yes, there are still major risks. The Chinese property market provides a significant proportion of the momentum driving the dynamics behind economic activity and also acts as a source of loan collateral. The situation remains risky in China for this reason.
Is global public debt a concern? No, although it reflects economies’ incapacity to restore strong sustainable growth. The aim of public debt is to extend the weight of the macroeconomic adjustment over time, which is effectively occurring. I am much more concerned by the persistently high level of household debt in the eurozone and by the increase in company gearing in the US. These phenomena are much more serious than the level of public debt, as they weigh on behaviour and reduce the chances of stronger growth being restored.

But growth has to accelerate for public debt to diminish? This reflects the issue at stake among innovation dynamics, which are creating gains in productivity at the microeconomic level but not yet on a macroeconomic scale. The optimistic view, which I subscribe to, is that in the foreseeable future, the cumulative effect of innovation and the maturity of the innovation cycle will lead to gains in productivity, which will set the economy on a more dynamic growth trend. The onus will then be on education to be able to accompany and amplify this new dynamic trend.

During the US electoral campaign higher customs barriers with China and Mexico were evoked, along with proposals to rescind US trade commitments? What has happened? Will these factors weigh on 2017? Several threats were effectively made regarding global trade during the campaign by the President-Elect. This remains a source of concern, even though there has been a slight shift in balance, due to the reactivity of the Chinese authorities who do not want to be put at a disadvantage. These proposed global trade measures incurred the risk of a strong durable downturn in trade, which would have a lasting impact on all economies across the board. Many research institutes feared their implementation for this reason. This could have triggered a global recession, including in the US. The President-Elect has suggested potentially rescinding the trade deal with Asia excluding China (the TPP agreement). This is probably simply rhetoric announced to please electors, as the agreement has not yet been signed by all of the countries involved. It would certainly be an error by the US, as Asian countries all trade with China as their main partner. Barack Obama wanted to seal this agreement in order to maintain a strong US presence in the region. A US exit from the TPP would provide an opportunity for China. In the short term, concerns regarding this international issue appear more political than economic, as any such move would not contribute to stability, which is nonetheless at least as disconcerting.

Philippe Waechter – Chief Economist – Natixis Aset Management