As we enter the last half of the year, we should take the measure of how the first half of 2018 stacks up against forecasts made in January. Readers may well recall that the major forecasting groups anticipated relatively strong economic growth for 2018. The IMF called for world GDP to grow at 3.9%, 0.2% higher than that experienced in 2017. The agency pointed to the positive growth aspects of changes in the U.S. tax policy and anticipated a broad-based continuation of the expansion enjoyed over the past half-decade. In particular, the EU nations exhibited signs of growth and improved employment. The emerging markets, according to the IMF, were slated to grow rapidly at 6.5% in 2018 in response to expansion in the developed world.
Against this backdrop, many U.S. experts expected the fixed income markets to reflect this positive outlook. Bond investors warned that, in all likelihood, expect the US 10yr bond to exceed 3% and possibly hit 4% before year's end. Inflation was expected to go beyond 2% and this would result in the yield curve shift upwards and resuming a more normal positive slope. On the equity side, fund managers, warned investors that they should not be caught short as equity markets would continue a relentless upward march started in 2017. The U.S. economy was operating in an ideal sweet spot, featuring full employment and moderate inflation; the risks going forward were relatively well-balanced. Investors were advised to put their cash to work in the equity markets at home. Similarly, those in the emerging markets were encouraged to load up on EM equities to take advantage of the strong growth emanating especially from Asia.
Alas, none of these forecasts seem likely to play out during the balance of 2018, for now conditions have changed, witness:
Equity markets
Central banks, with the exception of the Federal Reserve, have yet to commit to path of increasing in their rates; central bank policies in Britain, Europe, Canada and Japan are so dependent of incoming data, that with every new piece of economic data, the probability of rate hikes changes dramatically; there is a pronounced degree of nervousness in the central banks' meeting rooms;
The EU has been shaken by the political developments in Italy as that country enters an internal political struggle over its participation in the European Union; on top of this, the Brexit talks have not given us even a glimpse as to what the EU (and the UK) will look like at the end of the day;
The U.S. Bond Market is signalling that not all is rosy; the yield on the 10yr bond moved from 2.5% in January to 2.85% in late June, hardly a sign that growth and inflation are on the rise; moreover, the persistent flattening of the yield curve is a warning that a recession is looming; bond investors remain unconvinced that their investments are at risk from inflation down the road;
Emerging Markets are coming under considerable stress; Turkey, Argentina, Brazil and South Africa, for example, have considerable external debt denominated in USD; their currencies have undergone significant devaluations in the wake of the surge in the USD and their growth prospects are no longer what they were in the beginning of the year.
The China-US trade war is just starting to heat up; as yet, it is too early to assess the impact of the rise of protectionism, but the outcome will only be negative for the world economy.
