Economic Perspectives July 2018
- Recent evidence suggests that while the global business cycle is still in good shape, it may be facing some significant challenges. Developed economies, in particular the US, are doing better than emerging markets at present. On the one hand this is a result of the strong performance of the US economy that is supported by fiscal stimulus. On the other, the looming threat of a trade war disturbing the workings of global value chains poses large risks for a lot of export-oriented emerging economies. Due to its trade openness Europe may be negatively affected by escalating trade conflicts too.
- In recent weeks, the trade tensions shifted up a gear with the implementation of additional tariffs on US imports from China, Chinese retaliation measures in response to this and the implementation of retaliation actions from several other US trading partners due to higher US tariffs on steel and aluminium. Potential next steps could be even more import tariffs by the US and/or US tariffs on car imports. It is hard to predict when and how this trade conflict will end. Related uncertainties are already weighing on sentiment and investment decisions globally. A significant further escalation with increasing protectionist measures is hence the main risk in our global scenario.
- Higher-than-expected oil prices are putting some temporary upward pressure on headline inflation around the world. Preliminary June inflation data for the euro area pointed to a slight increase of headline inflation to 2.0%, while core inflation remains stubbornly subdued at only 1.0%. Also in the US we have seen inflationary pressures building. However, US core inflation, supported by the sustained strength of the economy, is moving in a similar upward direction as the headline series.
- Risk awareness on financial markets has risen of late. This led to increased safe haven flows towards Germany and to a lesser extent also to the US, Japan and Switzerland, causing the USD to strengthen and government bond yields to drop. In this context, we saw some intra-EU spreads and emerging market rates rising. This environment of increased global risk aversion with the corresponding flight to quality led us to lower the path of the German 10y government bond yields on a 12 months’ horizon. Given the US-German bond yield differential that will be larger than previously expected on a short-term horizon, together with the further market pricing in of monetary policy divergence, we expect the FX weakness of the Euro to continue in the short term.
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