WWRR Vol.2.015

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2019 Global Economic and Market Outlook Matthew Turner +44 20 3037 4340 matthew.turner@macquarie.com Gareth Berry +65 6601 0348 gareth.berry@macquarie.com Brexit and all that jazz Brexit is not likely to cause too many waves in the UK’s relationship with the EU in 2019. It’s what it does for the country’s domestic politics that investors need to focus on. That the exit deal is done and dusted may seem a rather reckless claim, but the evidence is already mounting that by early next year, UK/EU relations will probably be kicked into the long grass by European politicians. True, it will remain a major issue for a long time to come. But it’s a chronic pain rather than an acute one, and so is unlikely to flare up into anything that actually threatens the region’s growth outlook. We say this because there’s almost zero appetite within Britain’s political establishment for a “nodeal” exit when the time runs out on the Article 50 leaving process on 29 March 2019 and the UK exits the EU. The vast majority, including many of those who favour a “harder” or “cleaner” Brexit, want the so-called “transition period”, a period of at least two years in which the UK effectively remains a member of the EU. And the only way to achieve that is some form of deal. It is true the Withdrawal Agreement that the UK Government and the EU have spent the last 20 months negotiating, and which was finalised in late November, is not very popular domestically and is likely to be voted down when the government tries to get the necessary UK parliamentary approval in the vote scheduled for 11 December. The governing Conservative Party already lacks a majority, and in addition to the Opposition parties, the government’s parliamentary allies, the Democratic Unionist Party (DUP) and perhaps as many as a quarter of its own Conservative MPs are set to oppose it. Most of the Opposition MPs would prefer a closer relationship (or to remain in the EU), most of the Conservatives a looser one, and they join the DUP in rejecting the “backstop” which guarantees no border if all other methods fail by keeping Northern Ireland in the EU’s Single Market and all of the UK in its Customs Union, with exit only if mutually agreed with the EU. But while this level of opposition might seem game over, the Withdrawal Agreement still has a chance of passing eventually, on the grounds that no-one has a better plan, and that runs the risk of not leaving the EU, or leaving with “no deal”. Enough MPs of all parties might fear one of these extremes that they support the second-best option, especially if such alternatives are also put to a vote and soundly defeated. If not everyone can be happy then perhaps the only compromise is to make sure everyone is unhappy. Is there any room to improve the deal? Not much. It is unlikely the EU will make major concessions to the Withdrawal Agreement, which concerns issues to do with leaving such as UK’s financial liabilities, the rights of citizens of both territories, and the “backstop” for the Irish border. But there could be some room for movement on the accompanying Political Declaration, a non-binding statement of future relationship aims that the UK and EU have also agreed. The UK government negotiated this to be as close a relationship as possible while meeting their conditions of ending Free Movement, the policy in which EU citizens can work in each other’s countries, and allowing the UK to make its own trade deals. If those “red lines” were relaxed other possibilities open up. Recently some Conservative MPs have suggested such a “plan B”, which is also known as “Norway +” option. In this, the Political Declaration would be amended to see the UK commit to staying in the EU’s Single Market, like Norway, through the EFTA Agreement and the Customs Union (i.e. the ‘plus’). It also resolves the border with Ireland; so meaning the “backstop” would not be invoked, making it seem less threatening. As such it could command cross-party support: most Opposition MPs would like this and the DUP hard to oppose. The problem is (putting aside the question of whether the EU, or Norway, would be keen) it would be very divisive for the Conservative Party. The hardline Brexiters would see is as remaining in the EU by the back door and it would personally be very difficult for Prime Minister May given curbing EU immigration was her reddest of red lines. She would surely resign and the party could split, forcing an election which it would probably lose to Jeremy Corbyn’s left-wing Labour party. And this is the rub. The UK EU Withdrawal Agreement or something very similar remains the most likely deal, and a transition period overwhelmingly likely. But that it gains parliamentary approval smoothly by the votes of the Conservative Party and its DUP allies seems vanishingly unlikely. One potential route, relying on Opposition votes, risks the DUP pulling out of their agreement, another, the revised political declaration, would split the party down the middle. An extension to membership, or even (though we remain sceptical) another referendum, could do even more damage. The political landscape is likely to look very different in six months’ time, even if the UK’s relationship with the EU looks much the same. 4 December 2018 15
2019 Global Economic and Market Outlook David Doyle, CFA +1 416 848 3663 david.doyle@macquarie.com Neil Shankar +1 416 607 5055 neil.shankar@macquarie.com Stagflation 2020: Are we understimating US inflation risks? Core PCE price inflation could surprise on the upside relative to FOMC forecasts… Investors remain sceptical about the possibility of inflation pushing higher. Many continue to expect downside surprises to the FOMC’s 2% target for PCE price inflation. After rising earlier in the year, inflation break-evens have recently moderated and are well below levels experienced during the 2002-2007 economic expansion. The FOMC’s forecast projections also suggest some degree of inflation complacency. Despite forecasting unemployment to fall further below its long-run estimate in 2019/2020, the FOMC is suggesting only a modest rise in core PCE price inflation (to 2.1%) in both end-19 and end-20. Our outlook is somewhat more aggressive. While core PCE price inflation may moderate nearterm as a result of the sharp decline in oil prices, it could surprise on the upside relative to the FOMC’s forecasts by end-19 and end-20. Notwithstanding the potential for a near-term moderation, our baseline is for a gradual increase over the next 18-24 months. We project core PCE price inflation to gradually rise to 2.2% by end-19 and edge higher still to 2.4% by end-20. We believe underlying inflation pressures and trends are broadly underappreciated. While monthly momentum in the core PCE price index has recently moderated, this has been primarily due to weaker goods inflation. We provide a more complete inflation state of play in US Inflation Outlook: Gradual firming ahead, but with upside risks. …and we see risks to our view skewed to the upside There are several reasons we perceive risks to our baseline view as skewed to the upside on a 12- 24 month basis. I) Tariffs could lead to greater than expected price pass through, II) A tight labor market could lead to stronger wage growth than many anticipate, III) Fiscal policy remains stimulative, IV) While the recent sharp decline in oil prices should send a near-term disinflationary impulse, a subsequent rebound could push inflation higher in 2019 or 2020, and V) Dollar strength has helped to reduce upward momentum in inflation in recent years by suppressing goods inflation, but this may also change at some point in 2019. Underpinning our perspective is that core services inflation, which represents 75% of the core PCE price index exhibits much less volatility and is less influenced by moves in the USD. This has been steadily rising since 2009. This trend should persist as the labor market continues to tighten and wage growth pushes higher. Core goods inflation has been acting as a deflationary offset, but this could lessen in 2019. Tariffs are likely to lead to some price pass through and the tight labor market should contribute to stronger price pressures. Fig 18 Inflation break-evens remain moderate in contrast to the 2005-7 period Fig 19 We expect core PCE inflation to surprise to the upside relative to FOMC forecasts US treasury -10 year breakeven inflation index 2.9 2.4 1.9 2005-07 avg 29-Nov level Core PCE inflation forecasts (4Q on 4Q % change) 3.0% 2.5% 2.0% 2.0% FOMC Macquarie 1.8% 2.2% 2.1% 2.1% 2.4% 1.4 1.5% 0.9 1.0% 0.4 0.5% -0.1 2005 2007 2009 2011 2013 2015 2017 0.0% end-18 end-19 end-20 Source: Bloomberg, Macquarie Macro Strategy Source: Federal Reserve, Macquarie Macro Strategy 4 December 2018 16
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12/5/2018 From India to US Election
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Christopher Wood christopher.wood@c
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12/5/2018 Why You Would Not Have In
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India Economics “Strong growth to
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