The IMF Report: Short-Term Resilience, Rising Medium-Term Risks

The IMF/World Bank held their Spring Meeting in Washington. The IMF issued the semi-annual updates of its two major reports-the World Economic Outlook (WEO) and Global Financial Stability Report (GSFR).  In these reports, the IMF remained upbeat about the short-term outlook for the global economy, but warned about rising downside risks, especially in the medium- to long-term.

The IMF WEO report revised 2017 global growth upward to 3.8%, the strongest since 2011.  Economic growth for 2018 and 2019 is projected at 3.9% each, a 0.2% upward revision since the October 2017 WEO projection.  (Note that the IMF almost never projects a recession!).  The economic expansion of 2017 was driven by an acceleration in investment in fixed investments in advanced countries after several years of stagnation, strong emerging markets’ growth, a surge in global trade and higher commodity prices, as well as continued support from the major central banks’ monetary policy. The IMF Commodity Price Index has risen by 16.9% in the nine-month period ending February 2019, and world trade jumped by 4.9% last year. Advanced economies benefitted from under-performing inflation and loose financial conditions.

Looking at 2018 and 2019, the IMF sees a continuation of the 2017 growth dynamics:  a more expansionary fiscal policy in the advanced economies, resilient growth in the advanced economies and global trade expansion. In particular, the massive U.S tax stimulus package is seen as a major driver of global growth and trade.  In particular, the economic stimulus provided by the tax cut of December 2017 and the deficit-busting spending package of February 2018 should provide a further boost to global trade—as well as a further widening of the U.S trade deficit.  In the longer term, the IMF projects a slowing down of the global economy, as the major advanced economies revert to their potential pace.

The IMF reports underscores the resilience of the global recovery, but also points the risks to the global economy. While they see the short-term risks as balanced, they are gloomier about medium-term ones. At the same time, the reports minimize the probability of an economic downturn in the next two years.  The IMF underscores the following risks:

• Trade frictions could snowball into trade wars and protectionism
• A lengthy period of easy financial conditions leading to overreach in risky assets
• Financial markets vulnerable to inflation surprises
• High levels of public and private indebtedness and excessive use of leverage

The IMF and other multilateral financial institutions have underscored these risks in the past.  What is different now is that we are in the 105th month of the U.S economic expansion, the ninth year of a bullish stock market and the second year of a global synchronized economic boom. At the same time, major central banks are in the process of tightening monetary policy and normalizing their balance sheets.  Under these circumstances, the main risks facing the major advanced countries are abrupt adverse changes that could trigger an economic slowdown or even a downturn. We have seen in the past few months three such abrupt changes in the United States: the surge in market volatility after an extended period of calm, the jump in the 10-year bond yield and the sharp increase in oil prices. These factors, compounded by chaotic economic policymaking and the prospects of surging fiscal deficits and federal debt, have been the main cause of the stock market reversals in the first quarter of 2018 (1Q18).  Furthermore, their impact is not confined to the U.S economy.  Oil prices (Brent) are back up over $70/barrel, up 12.2% in the first quarter of 2018—and 42% higher from their 2017 low.  The FTSE-100 stock index is down 5% in 1Q18, and the global MSCI-EAFE index (covering advanced countries outside North America) is down 4.89%.

As usual, the IMF recommends that governments use the opportunity offered by the positive global conditions to reform their economies and strengthen the resilience of the financial systems.  That seems to be good advice!