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Sustained divergence: US growing alone

Key points

  • US GDP growth remains strong, at 3.5% annualised in the third quarter after 4.2%, and is likely to continue so in late 2018 and early 2019
  • Crossing the Atlantic, European Monetary Union growth keeps on disappointing, at 0.6% annualised, and business surveys falling further in October, down to a 25-month low for the composite Purchasing Managers Index
  • Brexit’s “darkest hour” overshadows the outlook for growth and monetary policy
  • Japanese real growth and core inflation look set to disappoint in the third quarter, the former probably contracting once again
  • A further slowdown was also witnessed in China with growth at 6.5% in Q3the third quarter, its lowest since early 2009
  • The macroeconomic data flow in emerging markets continue to point to weaker growth, albeit not to a collapse

US domestic strength but policy spreads weakness

The short-term outlook will be dominated by political developments in the shape of the US midterm elections. Current polling suggests an outcome of a mixed Congress, with Democrats set to become the majority party in the House of Representatives but Republicans retaining a majority in the Senate. As such, we envisage Congressional gridlock, scuppering the likelihood of major policy decisions next year and making budget negotiations more fractious.

This may also reverberate on trade policy. In the short-term, we have some hopes for the post-midterms meeting between US Presidents Donald Trump and China's President Xi Jinping at the end of November. We see some scope for ‘a deal’ that accepts Chinese commitments to protect intellectual property and increase market access. In turn, this may avert a final phase of US tariff threats on the outstanding $267bn of imports from China. However, beyond that we remain concerned that the US will proceed with raising auto tariffs, mainly as leverage in the US and European Union/Japan bilateral negotiations. Moreover, if our outlook for post-midterm political gridlock is correct, a frustrated Trump could well return to protectionism in the run up to the Presidential Elections, meaning that any post-midterms trade policy optimism is likely to prove short-lived.

US GDP growth in the third quarter (Q3) came in at 3.5% on an annual basis, only modestly slower than the 4.2% recorded in Q2. Consumption growth nudged modestly higher, still underpinned by the fiscal boost. Meanwhile an unwind of the net trade boost to Q2 was partially mitigated by a build in inventory. While we expect a modest deceleration in Q4, to 3%, there is some risk that growth exceeds our 2.9% annual growth forecast, something that would follow if growth exceeded 3.3% in the final three months of the year.

This solid momentum is likely to continue into the early stages of 2019, with fiscal easing likely to continue to boost activity – albeit to a smaller degree than in 2018. In addition, tighter financial conditions – higher rates, dollar and credit spreads, coupled with lower equities – are likely to weigh on growth next year (Exhibit 1). All told we consider GDP growth likely to slow to 2.3% in 2019 (consensus 2.5%). However, this pace would equal the average pace of expansion since 2009 and exceed our estimate of trend growth.

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