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Robust Global Economic Environment

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The global economic environment remains robust. Weakness seen across a large swath of developed economies in the first quarter looks temporary, and faster growth should emerge in the latter half of the year.

In the U.S., despite relatively slow growth during the first quarter, the impact of the fiscal stimulus
should push 2018 to challenge 2015 for the high watermark during the current expansion. 

The U.S. remains an important driver of global growth as the largest national economy, so a resurgence in the coming quarters should support a continuing global expansion. Growth in Japan and the UK, which also disappointed in early 2018, should rebound but come in below 2017's growth. Meanwhile, growth in the Eurozone slowed in the first quarter, but looks unlikely to rebound in the next few quarters. Political uncertainty, particularly in Italy, has not helped the economic situation: uncertainty can restrain consumption and investment.  

Among developing economies, India's economy looks poised to accelerate in 2018 and rank among the world's best performers, propping up global growth. Improvement in other economies, such as Brazil and Russia, should provide a minor boost to growth this year. And although China's growth remains strong, above 6 percent on a year-over-year basis, it is expected to slow slightly in 2018. Overall, global economic growth hit a few snags during the first half of the year, but the global economy remains on track in 2018 to achieve its strongest growth rate since 2011.

Divergent monetary policy

Divergent monetary policy marks one of the defining features of the current landscape. In the U.S., the Fed continues to tighten, raising interest rates at an increasing pace over the last few years. The U.S. economy has pushed further into the business cycle than other major developed economies which is why the Fed is raising rates while other major central banks are standing pat.

With the labor market reaching full employment and inflation beginning to accelerate, the
Fed continues to walk a tightrope: tighten too much and risk shortening the current expansion
or tighten too little and risk creating an asset bubble and, ultimately, a worse recession. 

The Fed looks set to raise rates by 25 basis points at least once or twice more this year. Meanwhile, other major central banks around the world remain rather accommodative in their policy. The Bank of England has previously hinted that it would be hiking rates this spring, but backed off after economic weakness in the first quarter. The European Central Bank recently communicated that it will begin slowing its asset purchase program later this year (its version of quantitative easing), but it is unlikely to even consider raising rates until sometime next year. And the Bank of Japan remains no closer to tightening policy. It recently had to relax the timeframe for its 2-percent inflation target due to weak inflationary readings.

This divergent monetary policy holds important ramifications for the global economy. As U.S. interest rates widen relative to the rest of the world they will pull capital into the U.S. and away from other countries. Widening rates should also drive the U.S. dollar higher as global investors target higher yields. Developing economies face the greatest risk in this environment. Rising U.S. rates tend to put upward pressure on developing economy interest rates. And when accompanied by a strengthening dollar, rising interest rates put dollar-denominated debts in developing economies under pressure and potentially slow their economic growth.

Global trade facing strains

Trade protectionism has garnered many headlines recently and cast a shadow over otherwise positive trade data. Global trade could increase by roughly 4 percent in 2018.  But trade policy decisions loom over that forecast. The Trump administration implemented tariffs on steel and aluminum imports, prompting retaliation from U.S. trading partners. It then placed $50 billion worth of tariffs on imported Chinese goods, threatened another $200 billion in tariffs on imported Chinese goods, and potential restrictions on sensitive Chinese investment in the U.S., particularly technology. China, as expected, signaled that it will retaliate in kind. The Trump administration has also recently been threatening increased tariffs on automotive imports from Europe. Meanwhile, after pulling the U.S. out of the Trans-Pacific Partnership (TPP) trade agreement, the administration has also threatened to withdraw from the North American Free Trade Agreement (NAFTA). The NAFTA negotiations have proven contentious and have taken longer than many had expected.

What's the upshot? The fallout depends upon how far along the trade tensions progress. Thus far, the damage remains limited.

But if the threatening measures are implemented, particularly the tariffs between
the U.S. and China, they would reduce economic growth in both countries, as well as global growth. 

All of this comes at a time when exports from the U.S. to the rest of the world recently reached record-high levels and trade deficits have come in somewhat smaller than expected. But rising interest rates and a strengthening dollar are likely to exacerbate the trade deficit in the U.S., which could keep trade issues on the radar screen of the Trump administration.

International Migration

The rise of populism in many places around the world has put migration flows at risk. This comes at a time when many developed nations around the world are aging, experiencing a slowdown in labor force growth. Slowing in labor force growth restricts economic growth, putting the onus on productivity growth to drive the growth in developed economies. That presents risk because productivity in the developed world has been declining over time and the specific process by which productivity grows remains elusive and unpredictable.

Implications for the U.S.

The robust global environment should provide support to the U.S economy, particularly through exports. Although export growth faces two key risks.

A rising U.S. dollar would make U.S. exports relatively more expensive around the
world while making imports into the U.S.
  relatively less expensive.

That would, all other things equal, widen the trade deficit. This would slow economic growth in the U.S. and feed into the second key risk, trade protectionism. Forecasting trade policy has proven incredibly difficult, with the Trump administration often saying one thing and then doing something different. But the empirical evidence thus far indicates that the administration will ultimately implement trade restrictions - it sees trade deficits as a problem to address.

These restrictive trade measures could prove counterproductive. Just the treat of trade protectionism can reduce hiring and investment which would slow economic growth. Moreover, such measures push up prices of both domestic and imported goods, effectively acting as a tax on U.S. consumers. And rising prices would likely cause inflation to accelerate at a time when inflation is already pushing higher. Disentangling the increase in inflation from input scarcity due to an expanding economy and the increase in inflation due to trade policy would present a significant challenge to the Fed. If they erred on the side of caution and raised rates more aggressively as inflation sped up, mistaking tariff-fueled inflation for scarcity-driven inflation, they run the risk of imperiling economic growth. The precedent for something similar exists – in the run up to the last recession, one criticism leveled at the Fed was that it didn't cut interest rates quickly enough heading into the downturn. Some at the Fed feared that increasing oil prices were fueling inflation, so cutting interest rates at the same time could exacerbate inflation even as economic growth was slowing. The word "stagflation" was used in 2008 to describe the economy for the first time since the 1970s. The effective Fed funds rate hovered above 4 percent when the Great Recession started in late 2007 (with oil at roughly $92 per barrel) and remained above 2 percent during the summer of 2008 (with oil reaching almost $140 per barrel) as the collapse of Lehman Brothers approached.

Relatively high interest rates vis-à-vis the rest of the world should keep funds flowing into the dollar-denominated assets in the U.S., particularly Treasuries. That should help restrict the upward movement on interest rates at the long end of the curve, which should cause the yield curve to continue to flatten as the Fed continues pushing up interest rates at the short end of the curve. In short, the global situation presents the U.S. economy with opportunities, but the risk surrounding trade policy will cloud the outlook until we have more transparency.

For commercial real estate (CRE) in the U.S., performance will take its cues from the macroeconomy. With growth set to accelerate in 2018, fundamentals should hold up relatively well, even in the face of rising construction across multiple property types. But if any of the risks that we previously highlighted come to fruition and limit economic growth, that would present problems for CRE fundamentals, particularly demand.

On the capital markets sides, the continued flood of dollars into the U.S. has not yet found its way into CRE in a meaningful fashion. Both dry powder and interest in CRE remain elevated, including from foreign capital sources. Yet many investors remain cautious about investing at this relatively late stage of the business cycle while some fret about the expensive pricing in the market. And significant previous turnover of properties has sapped the desire of many new owners to re-trade so soon. But as interest rates continue to rise they will eventually put upward pressure on cap rates and downward pressure on prices when economic growth slows. Somewhat counterintuitively, that could ultimately spur an increase in transaction volume, including foreign investment.  

Please note there will be no weekly economic insights report next week. Happy Independence Day!

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