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Global Economic Perspective: July

24 July 2018 Franklin Templeton

Please see below for the Franklin Templeton’s Global economic perspective.

Trade Policies Cloud US Economy’s Positive Growth Prospects

We think the US economy remains in good shape, with the rate of growth potentially picking up, a labour market that is tight but attracting new workers, and inflation that still seems relatively subdued. Boosted by tax cuts and spending increases, these favourable conditions could continue for some time. The US Federal Reserve (Fed) has recently emphasised its upbeat assessment of US growth prospects, keeping it on course to continue slowly tightening monetary policy. But investors should be aware of the growing risks to this scenario further out, in our view. Foremost amongst these is the uncertainty caused by the Trump administration’s aggressive policies on trade, which—absent an improbable reversal in numerous policy areas—are likely to start to weigh on both US and global economic growth at some point. Indeed, they may have already started to do so.

US Dollar Strength and Trade Uncertainty Adding to Problems for Some Countries

Though the threats to global trade have dominated headlines, many of the more liquid G71 markets have maintained an uneasy equilibrium since the end of May. Judging to what extent and how quickly such trade-related concerns could affect the momentum of the global economy remains difficult for investors, but the topic seems certain to dominate agendas over the coming quarters and possibly well beyond. Some of the more extreme scenarios would be highly damaging, but we continue to believe a more rational economic approach is likely to prevail at some point, in order to prevent such outcomes. However, until such views can gain greater political traction in the United States, further outbreaks of market volatility seem inevitable.

ECB Upbeat about Growth Outlook, but Concerns on Trade Increasing

While the eurozone’s recovery is still reliant on the European Central Bank’s (ECB’s) monetary stimulus, its growth appears healthy (relative to potential), domestic demand looks solid and inflation has yet to meaningfully pick up. Nevertheless, if further uncertainty about global trade causes a more negative outlook to take hold amongst the region’s manufacturers, the current rate of expansion in the eurozone could slow. For all the optimism expressed recently by the ECB on the outlook for growth, the flexibility built in to its planned cessation of bond purchases at the end of 2018 could yet prove useful.

Trade Policies Cloud US Economy’s Positive Growth Prospects

We think the US economy remains in good shape, with the rate of growth potentially picking up, a labour market that is tight but attracting new workers, and inflation that still seems relatively subdued. Boosted by tax cuts and spending increases, these favourable conditions could continue for some time. The Fed has recently emphasised its upbeat assessment of US growth prospects, keeping it on course to continue slowly tightening monetary policy. But investors should be aware of the growing risks to this scenario further out, in our view. Foremost amongst these is the uncertainty caused by the Trump administration’s aggressive policies on trade, which—absent an improbable reversal in numerous policy areas—is likely to start to weigh on both US and global economic growth at some point. Indeed, they may have already started to do so.

There are already signs that market participants have started to price in the possibility of such a development, most noticeably in the US Treasury market. In terms of the US economy, prolonged uncertainty about trade policy could see more companies put planned investment on hold, dampening the boost to corporate expenditure provided by the recent tax cuts. Although the current positive economic trajectory means corporate earnings are likely to remain strong for a while, the imposition of further tariffs may exacerbate existing shortages of labour and materials, reducing profitability. Ultimately, given the current minimal growth in wages for US workers (after allowing for inflation) and with tariffs likely to increase the cost of many goods, the impact could eventually hinder consumer spending.

While such potential concerns lie ahead, the underlying strongly supportive backdrop for the economy has persisted. Indicators suggested a potential acceleration of economic growth, as consensus estimates for 2018’s second quarter fell in the range of 3.5% to 4.5%, significantly higher than the revised annual gross domestic product growth rate of 2.0% in the first quarter. After May’s buoyant labour market report, data showed demand for workers remained strong in June. A monthly addition of 213,000 positions beat consensus expectations, and was accompanied by upward revisions totaling 37,000 for the two previous months.

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