WWRR Vol.2.015

2019 Global Economic and Market Outlook
A dangerous year for the Fed…
As always, the Fed will be central to the outlook for many markets. To that end, while the FOMC
continues to guide the market toward 4 further hikes by the end of 2019 (the median of the dots
still has one in December and then three more in 2019), the “easy” part of the hiking cycle is now
over, with future meetings likely to be far more “data dependent”.
While some have interpreted the recent change in tone as signalling that the end of the tightening
cycle is near, with the market currently pricing only one hike in 2019, we feel the Fed is merely
being honest about the fact that the mystical “neutral fed funds rate” is unobservable in real time.
And while both the Chairman and Vice Chairman have said that the committee consider the range
to be somewhere between 2½% and 3½% – noting that after the December hike, the rate will be
close to the bottom of that range – this merely suggests that they will proceed with caution as they
have no strong doctrinaire view as to the appropriate terminal rate. Indeed, this is really just
describing the distribution of the dots, where the median remains 3%.
To us the key remains the labour market. Although they will never articulate their objective this
clearly, the Fed needs to slow monthly employment growth from the current rapid pace (the
average of the past 3 months was 218k) back down toward the 70k or so that would see
unemployment stabilise. While employment growth is likely to slow in the coming year as the fiscal
stimulus fades and higher rates begin to impact (the infamous long and variable lags) we expect
the labour market to remain more resilient than the consensus, with payrolls likely to still be
growing at an above 100k monthly pace at the end of 2019. In turn, this is likely to see
unemployment continue to fall toward 3¼%, and the gradual increase in wages growth seen in
recent years continue.
This suggests to us that while there is a risk that the Fed may take a pause for a time next year as
they assess incoming information (note that lower oil prices is already mechanically pushing
inflation – including paradoxically core inflation – lower for a time), they are still likely to increase
the rate a further 3 or 4 times over the course of the year.
With a press conference every month, we suspect Chairman Powell would like to move away
from the current quarterly timetable.
We note that while the market is currently focused on downside risks to growth, to us the bigger
risk is that wages growth will continue to gradually strengthen even as GDP growth slows to trend.
As with the neutral rate, ex ante it is very difficult to assess the level of the NAIRU. But with the
Fed’s estimate currently 4½% it is possible (maybe even likely) that an unemployment rate in
the low 3s could be challenging, as monetary policy is not the only thing that impacts the
economy with a lag.
Faced with early signs of “stagflation”, the 2020 FOMC would effectively have to either live
with higher inflation (unlikely given the experience of the 1970s), or actively push the
unemployment rate back into the 4s, which of course would significantly increase the risk of
recession in 2021 or 2022.
In our view, the Fed will be living very dangerously in 2019…
2019 Economic Outlook – Global Growth to Remain Above Long-Run Average
We expect global GDP growth to slow modestly to around 3% in the year to Q4 2019, as the US
fiscal stimulus fades, the Fed continues to hike and China slows a little further.
US growth is likely to slow from a fiscal charged 3.1% in 2018 (Q4 on Q4) to a still strong 2.4% in
2019. While many commentators have suggested that the US could slow more than this, we note
that the fiscal stimulus will continue to support growth for most of next year (albeit with a gradually
diminishing impact), while the US labour market has been very resilient to external shocks over the
past decade.
While higher mortgage rates are likely to continue to weigh on housing construction, it is now a
much smaller share of GDP than seen in previous cycles, and as such is unlikely to dramatically
impact the broader outlook.
Note that while we expect the Fed to hike another 4 or 5 times by end 19, taking the total
tightening to 3 percentage points in 12 increments, 200 basis points of that increase has
already occurred, with the market already pricing a further 50 basis points.
4 December 2018 4