Economic Analysis - Key Themes For 2018 - 01 JAN 2018

BMI View: Key global themes that BMI expects to play out in 2018 include a divergence between developed and emerging market economic growth, US-led conflict over trade and potentially with North Korea, and a regulatory backlash over disruptive technologies.

1. EM Growth To Accelerate While DMs Plateau : We expect an unusual dynamic to play out in 2018: real GDP growth in emerging markets (EMs) will accelerate, while developed market (DM) growth plateaus. Real GDP growth in EMs will rise by 0.1pp to 4.8% in 2018, whereas it will drop by 0.2pp in developed markets to 2.0%. This is in contrast with the pattern of recent years, wherein DMs have accelerated while EMs have gone through a growth slump.

EM Ex-China Picking Up As DMs Plateau
Real GDP Growth (USD Nominal Weights)
f=BMI Forecast. Source: BMI

We expect EMs to remain in an upswing thanks to relatively firm developed market demand, stable exchange rates (compared with recent years), largely positive investor sentiment towards EMs and gradually rising commodity prices. Indeed, regarding the latter point, the acceleration in aggregate growth will be largely driven by a sizeable rebound in growth for several key commodity exporters, including Brazil, Nigeria and Saudi Arabia. The uptick in growth for these countries, coupled with a more gradual acceleration in a plethora of other EMs, will be sufficient to counterbalance China's slowdown, in terms of EM aggregate growth.

2. Trade Disputes To Heat Up, Led By The US ...:One of our key themes entering 2017 was 'Global Trade Framework Under Scrutiny', and while US-led protectionist policy has not been implemented to the point that some had feared, 2017 is likely to have proven merely a prelude for things to come. Trade tensions between the US and China have been a 'phoney war' so far, despite President Donald Trump's election campaign rhetoric, and there has so far been more heat than light out of the White House on the trade front, with the most tangible outcome being the US withdrawal from the Trans-Pacific Partnership and the initiation of North American Free Trade Agreement (NAFTA) renegotiations. But we expect at least some of the White House's rhetoric to be turned into action in 2018. The Trump administration will able to move on some of its more aggressive and controversial foreign policy and trade proposals, having gotten tax reform out of the way. This ramping-up was signalled in November when the White House initiated an anti-dumping case against Chinese aluminium exports, the first time since 1991 that an administration has taken such an action against a trading partner.

3. .. .While The Rest Of The World Finds Common Ground : While the US becomes more protectionist, the rest of the world will steadily become more integrated in terms of trade. A key trend in this respect is that China will play an increasingly influential role across Asia, as the country boosts investment in the region through the Belt And Road initiative. China is already one of the single largest trading partners for most countries in South East Asia and will continue to be a major player in the Association of Southeast Asian Nations (ASEAN), as Chinese investment continues to flow into the region.

Another key element of the increasing trade integration in the rest of the world is the drive among Latin American countries to diversify their trading partners. This will take place in 2018, as governments seek to encourage export-led growth and, in Mexico's case, reduce reliance on the US. While unlikely to have a material impact on the region's economic performance in the immediate term, these efforts will lay the groundwork for stronger trade ties, primarily with Asia but also potentially with the European Union over the coming years.

Trade Burgeoning Ex-US
Export Destination, % of Total
Source: International Trade Centre

4. North Korea-US C risis Reaching A Pivotal Point: The North Korean nuclear missile crisis will remain the biggest threat to international security in 2018 and reach a decisive moment in the coming year, with the US either taking military action to destroy Pyongyang's weapons programmes, or both sides moving towards high-level dialogue aimed at reaching a formal modus vivendi. We estimate the risks of war at 30%. The most dangerous provocation by North Korea would be a nuclear missile detonation in the Pacific Ocean, in a sheer demonstration of power. It is unclear if this would trigger a US military response, and thus war, but it could be cited as a casus belli by the Trump administration.In our view, the Trump administration could sense a 'now or never' moment to prevent Pyongyang from developing a fully intercontinental nuclear arsenal, and launch a pre-emptive attack on North Korea. This would trigger a devastating new war in North East. There is also a possibility that both sides stumble into war through tit for tat escalations from a 'minor' skirmish or miscalculation.

5. The Big MonPol Experiment To End As Inflation Returns : Following on from our 2017 theme, 'From Deflation To Reflation', it is becoming increasingly clear that the tail risks to price pressures are increasingly concentrated on the side of inflation rather than deflation. Despite our expectation for waning commodity price gains, global headline inflation will pick up to a five-year high of 2.8% in 2018, from 2.7% in 2017. While this is most evident in some emerging markets, particularly those of Central and Eastern Europe, the decline in output gaps, rising sentiment and production, and soaring asset valuations in many developed markets are pushing central banks closer to the exit if they are not through the door already. Even in Japan, which has posted chronic flat-to-negative price growth for most of the past two decades, we project a surge in average CPI growth to 2.0% in 2018, versus 0.7% in 2017.

Conversely, with most high-frequency indicators pointing to continued momentum going into 2018, and core inflation bottoming out and heading higher, the risks are skewed toward greater tightening in the US than the market currently expects over 2018-19. The US Federal Reserve has already begun undertaking the unprecedented task of exiting quantitative easing, and with a more hawkish board and tax cuts at this stage of the economic cycle, the Fed has increasing ammunition to push for rate hikes - presenting upside risks to our end-year Fed funds rate forecast of 1.75% in 2018 and 2.25% in 2019 (which implies two 25bps increases in each year).

6. ' Lame D uck ' Leaders in West, Rising 'S trongmen' in East : One rather striking feature of the international political stage at present is the diverging fortunes of Western leaders and their Eastern counterparts, with the former looking relatively weak, while the latter are tightening their grip on power. This portends a high risk of policy stagnation for at least the next year or two in the Western hemisphere, but more reforms in the East.

US President Donald Trump has already been politically hobbled by the ongoing 'Russia-gate' investigation, an uncooperative congress, an unusually low approval rating for a new president, and the realisation that many of his campaign promises are unrealistic. German Chancellor Angela Merkel, too, has seen a major setback following general elections on September 24, 2017. As of December 2017, Merkel was struggling to form a workable coalition, but even if she succeeds, the search for her successor will accelerate ahead of the next election in 2021. In the UK, Prime Minister Theresa May's authority has been diminished at a crucial time amid Brexit negotiations, while Italy looks set to have a weak government after the 2018 elections. Mexico and Brazil, too, will be under lame duck leadership in 2018, with new presidents not due to take office until the end of the year.

By comparison, 'Eastern' leaders appear to be increasing their political power, as exemplified by Chinese President Xi Jinping's enhanced authority following the Communist Party of China's five-yearly congress in October 2017, and Turkish President Recep Tayyip Erdogan's successful constitutional referendum in April 2017. Another political leader who greatly increased his authority in 2017 is Saudi Arabia's Crown Prince Mohammed bin Salman, who is pushing for major reforms in the Kingdom. Elsewhere, Russian President Vladimir Putin and Indian Prime Minister Narendra Modi are also looking highly robust ahead of elections in 2018 and 2019, respectively.

7. Industry Disruption Backlash : 2018 will see increased regulatory scrutiny of the use of new disruptive technologies in established markets. We term this theme the 'industry disruption backlash' and expect it to mainly unfold in developed markets. The main tangible impact will be greater regulation of 'disruptive' players in industries including financial services (e.g. cryptocurrencies), energy utilities (e.g. renewable energy providers, particularly household solar), media (e.g. 'over-the-top' content providers such as Netflix), transport (e.g. ride-hailing and ride-sharing apps) and retail (e.g. Amazon). In some cases, regulation will slow the transformative impact that disruptive players are having on these industries.

In 2017, there has already been increased focus by media, lobbyists and regulators on the broader costs of the industry disruption that has resulted from the application of new technologies. The costs highlighted have included the destabilising impact on established industries that employ large numbers of people and provide important public functions. For instance, European policymakers have become increasingly concerned about the associated costs of supporting renewable energy and the impact the generation has on grid stability and the wider power sector.

8. Commodities Rebound Reaches Its Limits: Although we are positive on commodity prices from a multi-year perspective, we expect a pause in this uptrend in 2018. As of December 4, the Continuous Commodities Index had rebounded by 19.4% since the January 2016 low. As illustrated by the chart below, we expect gains to be far more modest in 2018. Industrial commodities will drive the overall slowdown in commodity price gains, having previously been the strongest performers over the past two years.

Additional Gains Will Be Gradual
BMI Commodity Price Indices, % Chg y-o-y
Source: BMI, Bloomberg

Oil prices will stagnate as commitment to the ongoing output deal between OPEC and non-OPEC producers wanes. With the main goals of the deal (namely higher prices, weaker US shale production growth and lower global oil inventories) all in the process of being met, barrels held back from the market in 2017 will partially return over 2018, either officially or unofficially. This dynamic will keep a lid on prices and we forecast Brent Crude to average USD57.0/bbl in 2018 compared to a December 4 price of USD63.7/bbl.

Industrial metal prices will consolidate due to a marked slowdown in China's metals consumption growth. A government-led rebound in China's construction industry growth since early 2016 has underpinned the rebound in industrial metal and coal prices over the past two years. In contrast, we expect 2018 to see weaker public infrastructure spending growth and more stringent efforts to curb real estate speculation. Ferrous metal (iron ore and steel) and nickel prices will be most exposed to this slowdown, and we expect them to underperform base metals generally.

Industrial Commodities To Underperform
Select Commodities - 2018 Average Price Forecast, % Difference From Spot Price
Note: Industrial commodities highlighted in red. Correct as of November 30. Source: BMI, Bloomberg