Global Economy Strength to Continue – Goldman Sachs

For the first time since 2010, world economic growth is surprising to the upside and its strength should continue according to GS’s chief economist Jon Hatzius.

Per GS’s note (bold passages emphasized by us):

« On the supply side, we have also seen tentative signs of a rebound in productivity growth from its dismal post-crisis trend. Nevertheless, spare capacity is diminishing rapidly—and already exhausted in a number of advanced economies, including the US. There, the question is no longer whether output will overshoot potential, but by how much. By contrast, Southern Europe needs several more years’ strong growth to return to full employment.

If the output gap has largely closed, why is core inflation still so low? Our analysis suggests that a good part of the answer lies in a sizable and relatively long-lasting drag from the earlier weakness in import and commodity prices, which has offset the relatively small (though statistically highly significant) impact of diminishing slack so far. Over the next year, these pass-through effects are likely to diminish and we expect a gradual increase in global core inflation, albeit to levels that are still below central bank targets in most places.

If inflation does move up, the strength in activity will soon feel like “too much of a good thing” for some central banks, which need to slow growth to a trend rate to prevent a bigger overheating—and bigger recession risks down the road. So our Fed call is considerably more hawkish than market pricing, and we are also above the market in smaller G10 economies such as Sweden and Australia. By contrast, our ECB and BoJ call remains modestly dovish to the market.

For now, faster Fed tightening is unlikely to weigh significantly on DM growth, where divergent monetary policies typically have limited net financial spillovers. And while the impact on emerging economies could be more significant, we think that recent structural adjustments have left EM economies more resilient than in past Fed tightening cycles. The bigger near-term risks to the outlook are likely political, ranging from the future of NAFTA through the Italian election to the risk of military conflict on the Korean peninsula. »

GS expects global GDP growth of 4% in 2018 after 3.7% in 2017 and 3.2% in 2016.

Core CPI is expected at 1.7% in the US in 2018, 2% in 2019; 1% in Euro Area in 2018 (1.2% in 2019).

GS sees Policy Rates at 2.38% in 2018, 3.37% in 2019 in the US; -0.2% in 2018 and 0.10% in Euro Area.