The six members of PIMCO’s Global Advisory Board, a team of world-renowned macroeconomic thinkers and former policymakers, recently joined the discussion at PIMCO’s annual Secular Forum, where they addressed critical factors likely to shape the global economy over the three- to five-year horizon. The board’s insights constitute a valuable input into PIMCO’s investment process. The discussion below is distilled from their far-ranging conversation.
Q: What is the outlook for U.S. growth, business sentiment and monetary policy over the secular horizon?
A: Tailwinds supporting continued U.S. growth, at least over the early part of the secular timeframe, include the synchronized global recovery, accommodative financial conditions, tax reform, the regulatory environment and the fiscal policy impulse. Demographics are a drag on growth, but over time we could see productivity begin to improve.
“If tightening financial conditions do some of the Fed’s work for it, then it doesn’t have to be quite as aggressive on short rates.”
- Ben Bernanke
Recent tax reform, along with a more business-friendly regulatory environment, could boost U.S. business confidence significantly. The move to a territorial tax system helps businesses make capital allocation decisions based on efficiency and strategy, not just tax awareness – and they now feel they’re on a more level playing field relative to their non-U.S. peers. And while we’re not necessarily seeing a significant rollback of regulation, the absence of any prospect for substantial further regulation removes a major source of uncertainty for many businesses. In the longer term, however, the significant increase in the deficit implied by recent policy changes will likely reduce U.S. fiscal “space” and the government’s ability to respond to new challenges.
Inflation is increasing in the U.S., but only moderately. The Federal Reserve believes the Phillips curve is quite flat, meaning that low unemployment won’t necessarily translate into an acceleration in inflation. Moreover, the Fed appears willing to accept a modest overshoot of its inflation target. Accordingly, we expect the Fed will continue to raise rates gradually, though it may overshoot neutral at some point. The Fed has reasonable policy tools to respond to the next economic downturn, which could feasibly arrive over the secular horizon, provided the recession is not too deep. However, given the Fed’s limited room to cut rates and the reduced scope for fiscal expansion, a more severe recession would challenge policymakers.
Q: What are China’s longer-term economic goals now that the leadership has consolidated power? And how could developments in China affect the global economy and trade relations?
A: China’s leadership, united under President Xi Jinping, has a clear sense of direction and the will to pursue its objectives. Xi has a timeline for increasing China’s economic strength and influence over a span of decades, including the goal that by 2049 (the 100th anniversary of the founding of the People’s Republic), China will be a fully developed, rich and powerful country with a GDP per capita similar to Germany’s today. Three additional policy priorities over the next several years are to eliminate poverty, reduce pollution by imposing environmental standards and control risk in the financial system.
“China is looking very far ahead, and planning in terms of decades.”
- Ng Kok Song
Beyond its domestic priorities, China is also a major engine of global growth. We will likely see China’s GDP increase at least 5%–6% annually over the next three years even as the growth outlook elsewhere becomes less certain. China’s long-term growth is not likely to be derailed by trade conflict; unlike in years past, it is now much more dependent on internal consumption than external trade.
We see a greater risk of deterioration in the U.S./China trade environment than markets seem to be pricing. We expect prolonged tensions and the possibility of unintended escalations and flare-ups, and we also acknowledge there are some political incentives on both sides for continued low-level skirmishing and posturing in the trade arena.
As a secular base case, we expect a muddle-through scenario between the U.S. and China that stops short of unraveling the global trading system. It is possible for the parties to make progress on issues related to trade deficits and foreign investment, but any challenges to China’s growth model of state capitalism, which gives the state a leading role in industrial planning and in fostering research and development, will meet firm resistance.
Q: What are the longer-term outlooks for the European and U.K. economies?
A: Europe’s growth has been stronger recently, but its longer-term potential is hindered by structural problems: labor market inefficiencies, a lack of physical investment, and the different economic conditions and levels of competitiveness between core and peripheral countries. Populist politics are creating new barriers to trade, immigration and further European integration. Other political uncertainties include worries about trade wars, possible sanctions on Iran and Russia, and the uncertain resolution of Brexit negotiations. In this environment, we don’t expect progress toward a fiscal union. However, work continues toward banking and capital market unions.
Despite greater populist influence in a number of countries, the euro remains broadly popular. However, diversity in economic conditions and inflation among countries using the euro has complicated the task of the European Central Bank. We expect the ECB to remain dovish, perhaps extending its asset purchases beyond September 2018 and pushing off its first rate hike until the latter part of 2019 at least.
In the U.K., the economy remains sluggish and fragile due to reduced immigration (including by EU citizens), weak productivity growth and some fiscal austerity. Unemployment has fallen to low levels but wage pressures are modest.
The secular outlook for the U.K. hinges largely on the resolution of Brexit. The belief that the U.K. will be better off after leaving still prevails among those who supported the original referendum, even among those likely to suffer the most – the northern areas reliant on industries such as autos and pharmaceuticals, for example. Thus far, there is little clarity or convergence of popular support for a specific Brexit option. It is likely the Brexit timeline – currently formal departure in March 2019 and the end of the transition stage in 2020 – will have to be pushed back again in the case of the customs union and single market to 2021 or possibly even 2022. This would give businesses more time to prepare and may allow a rethink, but it would also extend the period of uncertainty that is weighing on investment and consumer confidence.
“It is likely that Britain will start negotiating for a longer transition period [for leaving the EU]. It is a period of huge uncertainty and will remain so for some time.”
Q: Are we likely to see major geopolitical developments or conflicts in the next few years?
A: As a framework to think about 2018, we can look back a few decades and see how uneventful years are sometimes followed by seismic geopolitical transformations, both negative and positive. For example, consider 1978, a fairly unremarkable year. Yet in 1979, the Soviet Union invaded Afghanistan, we saw the Iranian revolution, and the Cold War intensified. Or consider 1988, another quiet year. Yet in 1989, the Berlin Wall fell, and within a few years we saw the Oslo accords, the Maastricht Treaty, and the demise of apartheid.
In this spirit, does 2018 presage a darker turn in geopolitics similar to 1978, or a more positive outlook similar to 1988?
In the pessimistic view, the secular horizon could see tensions escalate with North Korea, prompting destabilization in Asia more broadly even as more countries look to China for global leadership. In the Middle East, we could see a “hot war” erupt, rather than the “proxy war” we see today. Russia could encroach further on Eastern Europe and escalate its campaign of cyber infiltration. Europe could see authoritarianism and populist pressures mount.
In the optimistic view, we could see genuine and meaningful negotiations toward peace on the Korean Peninsula, more promising developments and possibly even regime change in Iran, and perhaps a truce or stalemate rather than active conflict in Syria. Europe could respond to pressures from Russia and elsewhere by strengthening its integration efforts, such as for common defense and immigration policy.
Over the secular horizon, the geopolitical environment seems somewhat more likely to devolve toward the more pessimistic view, but there is also real potential for historic positive breakthroughs in a number of critical areas. Over the secular horizon, market participants will need to broaden their focus to take into account geopolitical as well as purely economic developments.
For PIMCO’s detailed insights into the longer-term trends shaping the global economy and market environment, please read our latest Secular Outlook, “Rude Awakenings.”