In A Better Place: Soft And Hard Data Are Converging
Earlier in the year, market participants worried about the discrepancy between the soft data which pointed to expectations of a stronger business environment and hard data which was not meeting elevated expectations. In recent months, that gap has tightened, with economic activity in developed markets exhibiting strength and beating forecasts. This harmonizing of the hard and the soft data gives confidence in the sustainability of the recovery.
Still Here?: Structural Issues Remain
Despite this, structural impediments remain headwinds to growth. Investors find themselves in a place not much different from the one they had hoped to leave behind—steady if sluggish growth, global low rates, halting inflation and low productivity. While U.S. GDP did indeed come in at a 3.1 percent rate for the second quarter, growth is expected to come in around 2.2 percent for the year, slightly higher than trend. In the longer term, without a fiscal boost, it will be challenging to push growth to 3 percent with the U.S. job market already at full employment, historically low levels of labor participation, and slow gains in productivity.
Don’t Touch That Button: Policy Risks Grow
Heightened geopolitical risks in Asia and Europe and the administration’s preference for unilateral action increase the likelihood for an unintended outcome detrimental to both global assets and geopolitical stability. North Korea’s testing of an ICBM and China’s unwillingness or inability to reign in the regime stand as major threats to global order and could affect growth in Asian economies. On the trade side, the U.S. pledge to move away from multilateral international trade regimes in favor of bilateral trade deals lies at the heart of the administration’s trade agenda. Even so, recent U.S. trade actions have been less punitive than feared, helping lead a rally in emerging markets and currencies since the beginning of the year.
On the monetary policy side there is a real, though low risk of a policy mistake. The lack of global inflation is the central conundrum for central banks given that all have the policy mandate of price stability. Therefore, if the causes of low inflation remain a “mystery” then we have a policy problem. On the one hand, low global and domestic inflation reads are keeping central bankers cautious in normalizing policy. Some members of the FOMC believe that the hesitation to raise rates could lead to a future inflation spike leaving the Fed with no choice but to act aggressively. Others believe that any rate increase in the current tepid inflation environment could choke nascent recoveries given the clear global down drift of wage growth and service and goods inflation.