World economy on the upswing
Global growth prospects for 2018 remain positive, with the International Monetary Fund (IMF) and World Bank retaining their GDP growth projections of 3.9% y/y and 3.1% y/y respectively, compared to estimated 2017 growth of 3.8% y/y and 3.1% y/y. Advanced Economies (2017: 2.3% y/y, 2018F: 2.5% y/y; IMF) lead the charge and continue to grow above recent trend, supported by resilient consumer spending and ongoing monetary stimulus in the European Union (EU) and Japan.
Growth should also quicken across emerging markets (2017: 4.8% y/y, 2018F: 4.9% y/y; IMF), propelled by strong commodity prices and healthy external demand. The risks to this outlook are three-pronged. Firstly, higher commodity prices are good for commodity exporters but pose a minor threat to global inflation – though analysts must point out that inflation in Advanced Economies remains rather stubborn.
In addition, evolving trade tensions and financial market weakness, amid worries of emerging market debt or deviations in monetary policy, also dampen bullish sentiment for the next six to twelve months.
Good times set to last in the shale industry
Led by the shale industry, United States (U.S.) oil production has risen dramatically, breaching the 10.5 mb/d mark in April 2018 and taking the country within reach of Russia’s title as the world’s biggest oil producer. Notably, the U.S. shale industry is enjoying the best of both worlds as producers have been able to expand output (and tussle for market share) while also enjoying high margins not seen since late-2014 as oil prices have remained resilient despite U.S. shale growth.
The industry is in a much better shape than in recent years, and with improved cash flows supporting capital expenditure, looks more resilient and able to withstand any downtrend in oil prices compared to 2015/2016. Production should remain strong for the rest of the year, though analysts expect growth to be constrained by declining well productivity and see U.S. production peaking just under 11 mb/d in this year.
Does the OPEC production increase mean the market has rebalanced?
OPEC producers have overshot their output cut targets in 2018 and this has supported the rally in oil prices. However, not all supply cuts have been intentional, with Venezuela being the largest inadvertent cutter. The country’s production has been in a freefall as it battles a wider economic implosion.
Output has slumped from 2.4 mb/d in 2010 to 1.4 mb/d in May 2018 and is likely to fall even further as the state-owned oil firm considers declaring Force Majeure on some of its major contracts. Amid this, along with stronger than expected oil prices so far this year, OPEC agreed to increase its production by 1 mb/d in the second half of 2018.
Whilst this looks like an existential challenge to the previous arrangement, analysts note that oil stocks have been severely depleted this year amid the output declines and rising global demand, and moreover, a number of countries would struggle to expand output even if they wanted to.
Beyond Venezuela, Nigeria’s production has suffered from pipeline leaks in the last month while Libya has been unable to expand output beyond the 1 mb/d mark. All of this means that the proposed 1 mb/d expansion would likely be driven by major players such as Saudi Arabia and Russia
Moreover, the amended deal does not completely remove the OPEC price support from the market, but rather preempts the possibility of a market deficit in 2019. Nevertheless, the move signals that the balance in the oil market has tilted and accentuates the importance of global demand and geopolitics in propping oil prices.
Analysts expect prices to trend lower in H2’18 (average of $71/bbl by mid-June) on the back of the reduced OPEC market support.
Strong price outlook amid geopolitical tensions
All in all, global oil prices are unlikely to reach the heady days of $80/bbl briefly flirted with in late-May 2018, but can take solace from a positive outlook for global oil demand as the global economy chugs along. Moreover, geopolitics may assume an outsized influence in the event of weaker OPEC support. On this front, analysts can expect prices to remain firm in the near future, propped by the Iran sanctions and concerns about a global trade war.
All things considered, analysts expect oil prices to average $67/bbl (average of $71/bbl in mid-June).
Shiny prospects for metals and other commodities
Analyst’s initial bullish expectations for commodity markets in 2018 has played out and prices are expected to remain strong through the year. Food prices have rebounded strongly after their 2017 dip, helped by cereals and dairy products. Wheat prices are on an uptrend on the back of concerns over prolonged dryness in the U.S. and poor weather in the Europe, and lead the cereals charge whilst surging global demand for cheese and milk should support dairy products.
In contrast, sugar prices fell to 3-year lows in April 2018 and are likely to remain depressed in 2018 as good weather and supportive government policy boost production in Thailand and India.
For non-agriculture products, metals are expected to do very well in 2018 – World Bank forecasts a 9% y/y rise in average metal prices – with copper, nickel, and aluminum projected to do particularly well. The major drivers for the healthy price outlook here are strong global demand and pollution-bashing policies in China that have hit metals supply.
Meanwhile, the evolving trade war could put further upward pressure on metal prices. Whilst the overall outlook bodes well for commodity exporters, stronger commodity prices may stoke higher global producer price inflation.
Trump’s economic policies bring both good and bad to U.S. economy
The United States (U.S.) economy has picked up where it left of in 2017, growing 2.2% y/y in Q1’18, compared to 1.2% y/y and 2.9% y/y in Q1’17 and Q4’17 respectively. Amid this, President Trump has gone about implementing some of his major pre-election promises, from enacting tax cuts and amending the Dodd-Frank Act to kicking off a potential tariff war with key trading partners.
Whilst the tax cut and Dodd-Frank amendment should boost the U.S. economy in the short run, trade developments are a bigger worry. President Trump has taken aim at the world’s largest traders (and economies) such as the European Union (EU) and China, both of which have not been shy to retaliate – in June, the EU confirmed plans to target € 2.8bn worth of U.S. products after President Trump imposed higher charges on aluminum and steel imports from the EU. Trade talks with China have see-sawed and an escalation of tensions and tariff implementation would feed into producer prices and depress consumer demand in the near to medium-term.
Despite these threats, a hawkish U.S. Federal Reserve (Fed) has been encouraged by a resilient economy, low unemployment, and rising inflation (hit the Fed target of 2% in March) and should persist with its guided monetary tightening path going into 2019.
EU growth to beat prior expectations
The International Monetary Fund (IMF) upgraded its growth projections for European Union (EU) countries in its April 2018 World Economic Outlook (compared to January projections), with sizable revisions across the largest economies in the region. However, Q1’18 GDP growth came in surprisingly weak – 0.4% q/q, slowest since Q3’16, pressured by a stronger euro.
Nevertheless, growth for the rest of the year should be robust as consumer spending and net exports prop the economy. The primary risk to the healthy EU outlook is the political landscape in Italy where a new populist, anti-EU government threatens to derail the fiscal progress made in one of the region’s largest economies.
Away from that, inflation in the region is still low (once oil prices are stripped out) but the European Central Bank is likely to flip the monetary switch towards tightening in early 2019 – though developments in Italy would once again be key in determining the risk environment at the time.
UK economy slows, faces prospect of hard Brexit landing
The United Kingdom (UK) economy slowed in Q1’18 (from 0.7% q/q in Q1’17 and 0.4% q/q in Q4’17 to 0.1% q/q in Q1’18). Meanwhile, the Bank of England (BoE) continues to face a monetary policy dilemma; despite a slight recovery in the pound and strong base effects from 2017, annual inflation remains well above the Bank’s target, limiting its scope to turn monetary policy towards stimulating a weak economy.
This dilemma may be here to stay; even with a supportive global environment, household spending and investment are likely to remain sluggish on the back of Brexit.
The UK and EU agreed a transition period between the official Brexit date (March 2019), when the UK would leave the EU, and the end of 2020 – a period in which the UK would remain part of the customs union and single market despite being a non-EU country. As a member of the customs union, the UK would remain subject to EU regulations and could still benefit from easier trade access, but would lack the voting and decision-making rights of a full-fledged EU member, a potentially unattractive situation for the UK.
Meanwhile, the transition period mainly defers the big exit decisions till the end of 2020 (including the post-Brexit nature of the relationship between the two parties), but the positive is that the UK would be able to enter some level of trade negotiations with other countries during the period. All of this occurs against the backdrop of an impasse over the Irish border as neither party has devised a mutually appealing Brexit framework that would ensure no borders between Northern Ireland and the Republic of Ireland, despite many proposals and counter-proposals.
Analysts note that the Irish border issue has been a long-term sticking point, and given the nature of Brexit negotiations – all terms must be agreed on for the deal to be ratified – the socio-political precarity of the Irish border could seriously hamper Brexit negotiations, an uncomfortable reality as the UK heads towards the March 2019 Brexit point.
Asian giants to continue to set growth pace
The near-term outlook for major Asian economies is positive. The Chinese economy grew 6.8% y/y in Q1’18 as strong consumer spending – driven by e-commerce – overshadowed a continued slowdown in industrial activity. China’s gradual shift away from industry-led growth is evidenced by the fact that the country experienced its first current account deficit since 2001 in Q1’18.
Overall growth should remain strong, though the World Bank and International Monetary Fund expect a slowdown relative to 2017 as fiscal stimulus weakens and deleveraging kicks in across the economy – the World Bank and IMF project 2018 GDP growth of 6.5% and 6.6% respectively compared to 2017 growth of 6.9%. The primary risk to the Chinese economy is the escalating trade rift with the United States that could further worsen external balance.
Meanwhile, the Indian economy has rebounded nicely from the missteps of demonetization and a botched implementation of a goods & services tax in 2017. The World Bank and IMF expect the country to grow by 7.3% and 7.4% respectively, and India should retain its position as the fastest-growing large economy for the near future, but still needs to work harder to achieve inclusive growth.
Finally, the major Gulf states should be supported by healthy oil prices, while the primary risk comes from ongoing diplomatic rifts within the region that may hamper growth in smaller economies. On a final note, the Saudi Aramco listing has been effectively pushed until 2019 on account of “market readiness”
SSA growth economy buoyed by commodities
The International Monetary Fund (IMF) projects accelerating economic growth in Sub-Saharan Africa (SSA) as the region recovers from the 2014-2016 commodity shock. In particular, near-term growth prospects are boosted by firm commodity prices, particularly for the major regional economies – Nigeria, South Africa (SA) and Angola.
Looking more closely at these, the SA economy underperformed in Q1’18 – shrinking 2.2% y/y in seasonally adjusted terms vs. a consensus projection of -0.5% y/y, its worst quarterly performance since 2009. In fact, the initial feel-good factor of the Ramaphosa presidency has made way for harsher realities, with the rand shedding over 8% of its value between the end of 2017 and mid-June.
The IMF still expects 2018 to be a better year than 2017 (1.5% GDP growth vs. 1.4%), but the attainment of this level would depend on both political sentiment and commodity prices remaining healthy.
The Angola story is more positive, mainly due to higher oil prices, but a more efficient allocation of foreign exchange, rising natural gas production, and improved business sentiment would help support the rebound in economic activity. Meanwhile, things are less promising for Ghana, the region’s star in 2017.
The IMF forecasts choppy growth in the coming years and public finances remain a significant worry. Finally, East African economies should remain resilient – Kenya is one of the few major SSA economies that the IMF predicts would experience accelerating growth through to 2023.
Are we heading towards a global trade war?
After over a century of being the undisputed economic consensus, we may finally be departing from a world of relative free trade and heading into an era of protectionism. Sitting at the centre of this shift is Donald Trump, President of the United States, which for so long stood as the intellectual centre of the “trade is good” doctrine. President Trump had often targeted China’s large trade surplus with the U.S. in his 2016 campaign so it was unsurprising that he began to chip away at the U.S.’ trade relations with the Asian behemoth – earlier this year, he imposed trade sanctions on a range of Chinese imports, before China retaliated.
However, global trade patterns truly came under threat at the end of May when President Trump pushed through additional tariffs on steel and aluminum imports from the European Union (EU), Canada, and Mexico. China has always been a popular target but is not the U.S.’ main trading partner – U.S. trade with the EU was $720 billion in 2017, compared to $636 billion with China, whilst combined trade with EU, Canada, and Mexico rose above $1.1 trillion or 5% of the U.S. economy.
Yet, Trump imposed steel and aluminum tariffs on the EU, Canada and Mexico (44% of US steel imports in Q1’18), citing national security threats and dumping concerns. These countries swiftly retaliated, with the EU highlighting €2.8 billion worth of U.S. imports for trade sanctions that member states would ratify, while Mexico imposed tariffs on a range of U.S. goods.
Canada also outlined a tariff plan on $12.8 billion worth of U.S. raw materials and consumer goods, a development that may seriously threaten the North America Free Trade Agreement (NAFTA). Trade tensions came to a head in June as President Trump rejected a negotiated compromise agreement at the G7 summit, much to the chagrin of other Western leaders, with one particular photo highlighting the poor state of negotiations.
The threat to global trade comes at an inopportune time for a global economy where the EU continues to struggle with the euro’s underlying existential crisis and member states resistance to further integration, the changing structure of the Chinese economy poses a challenge to global commodity markets, and many emerging markets are still recovering from the last commodity bust.
Whilst it is hard to estimate the costs of a full-blown trade war, it is evident that the current trajectory may cause us to give up the primary gains from globalization – higher quality products at cheaper prices. Meanwhile, jobs and investment would be at risk under this new normal (the United Nations estimates that global FDI slumped 23% y/y in 2017 due to trade concerns) and the shift in economic consensus could hit long-term certainty and confidence as people adjust to the new rules of the global economic game.
Most worryingly, we are in uncharted territory because of how interconnected global supply chains are – some estimates suggest that global supply chains account for one in five jobs on the planet – and it would be reasonable to expect a surge in global inflation as trade sanctions stack up. For Nigeria, it would be operating in a more hostile global economic environment, which would be particularly unfortunate given the country’s aim to diversify exports.
Ultimately, though the evolution and outcome of a trade war is hard to call, it is likely to lead to an arms race to the bottom and create losers all round.
Source: Analysts at Vetiva Capital Management Limited.
Reporting for EasyKobo on Wednesday, 27 June 2018 ( Lagos ) in Lagos, Nigeria