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By Western Asset, a Legg Mason affiliate
Global growth is likely to remain positive in 2019, as US growth moderates slightly and Europe and emerging markets (EM) regain their footing. We also acknowledge four major global risks which may challenge this view – a collapse in US-China relations, the Federal Reserve (Fed) over-tightening, Italy’s governance pulling away from European Union (EU) fiscal norms and the UK separating from the EU via a “hard Brexit.”
The market, however, is already pricing each of these scenarios for extremely negative outcomes. We believe there is room for less pessimism – even some optimism – regarding each of these factors.
United States – growth to moderate
US growth is likely to be slower in 2019 as some of the fortuitous factors recently boosting growth begin to fade. Given the 2017 tax bill’s incentives, one would think capital spending would continue to hum, but recent capital goods data has been spotty, and homebuilding looks to have embarked on a downtrend. If foreign trade and inventories revert to 2015-2016 trends and either equipment investment or housing slow, economic growth could drop to around 2.0 – 2.25%. We think the claims of runaway growth are exaggerated and that we will likely see more modest performance in 2019, along with continued low inflation.
The Fed’s renewed focus on contained inflation, risk management and a lack of certainty about equilibrium or neutral rates suggest a more dovish direction moving forward. What’s more, Fed Chair Jerome Powell just declared that the Fed is very near the neutral range (thought to be a fed funds rate of 2.5 – 3.5%). We’re optimistic that the new tone will prove helpful, but it’s too soon to tell. More importantly, monetary policy has been tightening for two years and fiscal stimulus is waning. We think as the Fed comes to face more seriously a moderating growth and inflation outlook, a pause will be both signalled and warranted.