December 2017 Exclusive Story
Operators Lock In 2018 Oil Hedges
HOUSTON–The political earthquakes of 2016 have upended conventional thinking and brightened the global economic outlook. The expectation that the incoming Trump administration will enact a sizeable fiscal stimulus package has increased optimism about both U.S. and international economic growth, which in turn, has pushed U.S. stock indexes to record highs and drove up both interest rates (with a resulting rout in the bond market) and the dollar.
A stronger dollar is mostly good news for Europe and Japan, boosting both export growth and inflation expectations. On the other hand, much higher U.S. bond yields are bad news for the emerging world, where currencies have already taken a beating, significantly reducing the scope for further monetary easing. Fortunately, these financial market gyrations are occurring at a time when commodity prices are rising and both consumer and business sentiment are improving.
The balance of these trends should be moderately positive for global growth, which is expected to increase from 2.4 percent in 2016 to 2.8 percent in 2017 and 3.0 percent in 2018. That said, high levels of political and policy uncertainty could hurt growth this year and beyond.
Looking at the big picture, IHS Markit believes the U.S. economy will accelerate, even before Trump enacts any stimulus program. U.S. gross domestic product growth was reduced to 1.6 percent in 2016 by the combined impacts of a large inventory drawdown, the collapse in energy-sector capital spending, and the drag from net exports because of a strong dollar and weak global growth. The good news is that during 2017, a much smaller drag from inventories and a rebound in energy-sector capital spending will boost growth.
Tax cuts and infrastructure spending will likely be enacted by the Trump administration and a Republican-controlled Congress. While the stimulus will not have much of an impact on 2017, it could boost 2018 growth by as much as 0.4 percent. Consumer and business confidence, which rebounded right after the election, are likely to be further increase as growth improves. On the downside, the rise in both interest rates and the dollar in anticipation of a stimulus program would erode some of the positive effects of stimulus. We predict U.S. growth will accelerate to 2.3 percent in 2017 and 2.6 percent in 2018.
The U.S. election results and the anticipation of strong growth–particularly more infrastructure spending–has buoyed commodity markets. In fact, the IHS Markit materials price index had surged to an 18-month high by the end of 2016. The euphoria may be somewhat overdone, but commodity prices should continue their upward trend in 2017.
Specific to the oil market, OPEC’s agreement to cut output by about 2 percent of world liquids production will turn a small production surplus into a deficit. As a result, we have nudged our dated Brent oil price forecast to an average of $58 a barrel in 2017, up substantially from the lows seen in spring 2016. However, oil price optimism must be tempered by the realization that OPEC members have a long history of less-than-100 percent compliance with output cuts. Moreover, rising oil prices would encourage more U.S. production, dampening future price increases.
Other economic predictions for 2017 include:
Incoming data on the Eurozone economies point to a near-term rebound in growth, while the U.K. economy is proving resilient. In particular, consumer and business surveys underscore the better mood in Europe. Nevertheless, Europe faces daunting political challenges that could hurt confidence and growth this year. These include a potentially contentious Brexit, fallout from the recent referendum defeat in Italy, and upcoming elections in France, Germany and the Netherlands.
On the positive side, the European Central Bank looks set to extend its bond-buying program, and a weaker euro will help to lift export growth and (along with rising oil prices) raise inflation rates. These conflicting forces will likely weaken Eurozone growth from 1.7 percent in 2016 to 1.4 percent this year. Likewise, we expect U.K. growth to fall from 2.0 percent last year to 1.4 percent. While the Brexit impact has been small so far, it will probably soon get worse.
Japanese economic data also have been upbeat, although domestic demand growth remains lackluster. The recent plunge in the yen is likely to accentuate these trends. The weak yen will fuel exports and tourism, support corporate profits, lift capital spending, and encourage further increases in stock prices. On the downside, higher import prices and inflation will erode consumer purchasing power and suppress consumer spending. On balance, Japanese growth should stabilize at around 1.0 percent in 2017.
China’s economic condition remains fragile at the start of 2017, with growth divergence in key sectors of the economy intensifying. Industrial production and retail sales have been stable, but investment has worsened in inflation-adjusted terms. Exports also have continued to rapidly contract. Most concerning, corrections in the housing and automotive sectors are likely to worsen in coming months. Worried about a housing bubble, the government has begun removing stimulus. This will further hurt construction. One counterweight is the recent improvement in the performance of some heavy industries and mining, as manifested by the ability of these sectors to raise prices after years of deflation.
China also faces another source of stress because of capital flight. Foreign exchange reserves are at a five-year low and the renminbi is back to 2008 levels. In response, the government already has imposed some capital controls, and will likely do more, in an attempt to relieve pressure on the currency and limit annual depreciation to no more than 5 percent. IHS Markit believes China’s policy contradictions will result in growth slowing from 6.7 to 6.4 percent in 2017.
The results of the U.S. election are something of a good news/bad news story for emerging markets. On the plus side, moderately stronger growth in the U.S. and global economies is good news for emerging markets whose economies are export-oriented. Moreover, the expected continuing rise in commodity prices will help bring in more export revenues and replenish government coffers. On the downside, plunging currencies mean dollar-denominated debt in the emerging world is rising rapidly. As the value of the dollar goes up, so does the burden of these debts. Central banks will have to pursue more restrictive policies to prevent capital flight.
The good news is that the economic fundamentals in most emerging markets have improved in the past couple of years. Also, with the exception of China, overall debt ratios are mostly down. Consequently, these economies should be able to enjoy the fruits of a more upbeat global outlook.
After many years of facing the threat of deflation, the world economy is on the threshold of an increased inflation. With the U.S. economy at or near full employment, wage inflation is already beginning to rise and is set to climb even faster with the implementation of fiscal stimulus. Along with increased commodity prices, this will translate into faster price inflation (exceeding 2 percent in the coming two to three years).
A similar upward trend also is evident in other parts of the world. Although still low, consumer price inflation is at a 39-month high in the Eurozone and deflationary pressures in Japan are beginning to ease. Even more promising is that after many years of falling, China’s industrial prices have risen recently.
Rising inflation in the U.S. economy, accompanied by a stronger dollar, means the United States will be “exporting” inflation. Specifically, falling currencies in other parts of the world will translate to higher imported and headline inflation. For example, Japan’s consumer price inflation is expected to rise to 1.0 percent and U.K. inflation could well end the year at 3.0 percent, much higher than in 2016.
Even before the U.S. presidential election, financial markets expected the Federal Reserve to raise interest rates. With expectations of a larger U.S. budget deficit and higher growth and inflation, we predict that the Fed will raise interest rates at least three times in 2017 and keep raising rates until the overnight federal funds rate reaches 3.0 percent by the end of 2019. In anticipation of more rate hikes, markets pushed the 10-year treasury yield roughly 70 basis points higher soon after the election.
Elsewhere, anxiety among central banks has risen. Both the Bank of England and the European Central Bank have warned that higher U.S. interest rates and political uncertainty on both sides of the Atlantic could “reinforce existing vulnerabilities” in the global financial system, especially in the emerging world and Europe. Higher U.S. interest rates have triggered a run on emerging-market currencies, forcing some central banks (e.g., Mexico and Turkey) to raise interest rates and others to halt any further rate cuts (e.g., India, Indonesia and Malaysia). In Europe, there are concerns about banking problems and a new round of sovereign-debt pressures.
An already-strong dollar climbed even higher in the wake of Donald Trump’s victory. By the end of November, the dollar had risen to an eight-month high against the yen and a 20-month high against the euro. Some of this was because of anxiety about the Italian referendum. Emerging-market currencies also were hit hard. In Asia, exchange rates fell between 2 and 7 percent.
In light of expected stronger growth in the U.S. economy and higher interest rates, IHS Markit predicts that the greenback will continue appreciating during 2017. On an effective trade-weighted basis, we expect the dollar to rise another 2-3 percent against key trading-partner currencies. The advance of the U.S. dollar will not be uniform. The biggest increases are likely to be against the euro and yen, as monetary policies in the Eurozone and Japan will be more accommodative than in the United States. Emerging-market currencies will fall much less because they have already seen large declines.
IHS Markit estimates the risk of either a U.S. or global recession at no more than 25 percent in 2017. The usual “recovery killers” are in abeyance. Even with expected interest rate increases, global monetary conditions remain extremely accommodative. The chances of central banks killing off the recovery are slim to none, and despite OPEC’s agreement to cut oil production, global markets are well supplied. This means the risk of an oil shock is low. Finally, there is little evidence of asset bubbles in most parts of the world, making the odds of a repeat of the 2008-09 financial crisis remote.
Unfortunately, political and policy uncertainties (and risks) are higher now than they were a year ago. The rise of anti-globalization movements in the United States and Europe could result in policies that hurt growth. On the other hand, business-friendly policies such as lowering corporate taxes and rolling back regulations could boost both short- and long-term growth.
Nariman Behravesh is chief economist at IHS Markit, responsible for developing economic outlooks and risk analyses for the United States, Europe, Japan, China and emerging markets.He has been covering the global economy for almost 40 years and is the author of “Spin-Free Economics: A No-Nonsense, Nonpartisan Guide to Today’s Global Economic Debates.” He holds a B.S. in economics from the Massachusetts Institute of Technology, and an M.S. and a Ph.D. in economics from the University of Pennsylvania.