Global Macro Outlook 8 2018 Moody

CROSS-SECTOR
OUTLOOK Global Macro Outlook: 2018-19 (August 2018 Update)

22 August 2018
Growth will remain solid in the near term,
but early indications suggest it has peaked
TABLE OF CONTENTS Summary
Overall economic momentum
remains solid, but upside to growth » We see early indications that global growth has peaked. Growth prospects for many
forecasts is limited 2 of the G-20 economies remain solid, but there are indications that the synchronous
An escalation of the trade dispute
between the US and China will
acceleration of growth heading into 2018 is now giving way to diverging trends. The near-
dampen global growth 4 term global outlook for most advanced economies is broadly resilient, in contrast to the
Crude oil price to remain elevated in weakening of some developing economies in the face of emerging headwinds from rising
the near term but moderate over the
medium term 6
US trade protectionism, tightening external liquidity conditions and elevated oil prices.
Selected forecast revisions 7 We expect the G-20 countries to grow 3.3% in 2018 and 3.1% in 2019. The advanced
Moody's related publications 15 economies will grow 2.3% in 2018 and 2.0% in 2019, while G-20 emerging markets will
remain the growth drivers, at 5.1% in both 2018 and 2019 (see Exhibit 1).
Analyst Contacts » US trade tensions with China will worsen this year, weighing on global growth in
Madhavi Bokil +1.212.553.0062
2019. Our base case now assumes that the US administration will go forward with some
VP-Senior Analyst of the proposed additional restrictions on imports from China. Further tariffs, similar in
madhavi.bokil@moodys.com magnitude to the newly proposed 25% US tariffs on $200 billion of imports from China
Youngjoo Kang +1.212.553.1124 and 25% US tariffs on all auto and auto part imports, represent a disruptive downside risk
Associate Analyst to our baseline forecasts.
youngjoo.kang@moodys.com
Elena H Duggar +1.212.553.1911
» Elevated oil prices, mounting trade tensions and tightening of financial conditions
Associate Managing Director already weigh on economic activity in many major emerging market countries.
elena.duggar@moodys.com External headwinds constrain near-term economic prospects in Turkey, Argentina and
Anne Van Praagh +1.212.553.3744 Brazil. In contrast, for India and Indonesia, robust domestic growth drivers and a build-
MD-Gbl Strategy & Research up of financial buffers in recent years have conferred a degree of stability amid external
anne.vanpraagh@moodys.com
headwinds. Overall, emerging market countries remain inherently vulnerable to the risk of
» Contacts continued on last page capital outflows associated with tightening global liquidity as advanced economy central
banks reverse their quantitative easing measures. Escalating trade frictions further add
CLIENT SERVICES
to overall uncertainty. Those with weak fundamentals and relatively shallow, but open,
Americas 1-212-553-1653 capital markets are particularly vulnerable.
Asia Pacific 852-3551-3077
Japan 81-3-5408-4100
EMEA 44-20-7772-5454
THIS REPORT WAS REPUBLISHED ON 27 AUGUST 2018 WITH AN UPDATE TO EXHIBIT 9.

MOODY'S INVESTORS SERVICE CROSS-SECTOR
Exhibit 1
Global macroeconomic outlook for G-20 countries, 2018-19
(August 2018 Update)
1. G-20 Euro Area forecasts include 19 countries. 2. CPI for Euro Area reflects average. 3. The authorities are using the inflation band based on numerical guideline.
Source: Moody's Investors Service
Overall economic momentum remains solid, but upside to growth forecasts is limited
Taking the global economy’s pulse, more than halfway through 2018 we see early indications that global growth has peaked. Growth
prospects for many of the G-20 economies remain solid, but there are indications that the synchronous acceleration of growth heading
into 2018 is now giving way to divergent trends. The near-term global outlook for most advanced economies is broadly resilient in
contrast to the weakening of some developing economies in the face of emerging headwinds from rising US trade protectionism,
tightening external liquidity conditions and elevated oil prices.
The US economy remains the driver of global growth. The growth outlook in the euro area remains constructive, despite moderation
from the heady performance at the start of the year. The deleveraging measures undertaken by the Chinese authorities to moderate
leverage growth are slowing economic growth in China, but no more than our expectations. The UK economy, which is decelerating,
faces further downside risks from Brexit. The outlook for developed Asia, namely Japan and Korea remains constructive, although both
countries are vulnerable to slower trade growth. Growth prospects for emerging market countries are decidedly mixed. Some, like India
and Indonesia, are expected to maintain growth close to trend, while others, like Turkey, Argentina, and Brazil, have stumbled.
This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on
www.moodys.com for the most updated credit rating action information and rating history.
2 22 August 2018 Global Macro Outlook: 2018-19 (August 2018 Update): Growth will remain solid in the near term, but early indications suggest it has peaked
Continued above-trend growth in the US, Europe and Japan strengthens the case for reduced monetary accommodation. Weak wage
growth in these economies remains the enduring mystery of this economic cycle – wages typically pick up at this point of an economic
cycle because a low jobless rate compels firms to increase wages to attract and retain workers. As such, inflation remains in check. But
in the US, in particular, economic conditions are supportive of further reduction in monetary policy accommodation (see Exhibit 2).
Exhibit 2
G-20 central bank policy
The shadow short rates measure the stance of monetary policy. For the purpose of international comparison, we use the shadow short rates estimated by Leo Krippner of the Reserve Bank
of New Zealand. See RBNZ's comparison of international monetary policy measures for methodology.
Sources: Reserve Bank of New Zealand, Federal Reserve Bank of Atlanta, Haver Analytics
We expect most major advanced economies to continue to grow at a robust, albeit slightly slower pace supported by positive
sentiment, strong employment generation and a highly supportive policy stance, both monetary and fiscal. Even in the US, where the
Federal Reserve has been on a monetary policy tightening course for some time now, the real federal funds rate remains negative (see
Exhibit 3). Looking forward, however, we see limited upside for advanced economies, most of which are already growing above trend
and facing increasing capacity constraints from employment. Moreover, our forecasts of around 2% growth in advanced economies in
2019 inherently assume an increasing contribution of labor productivity, as firms embrace technological innovations to offset the drag
from aging populations.
For emerging market countries, particularly Turkey, Argentina and Brazil, external headwinds constrain the outlook for their already
fragile economies. The steady firming of crude oil prices by around 65%, with Brent rising from a low of about $46 per barrel in June
2017 to a peak of $77 in May 2018, has significantly increased the import burden for large oil importers such as Turkey and India. The
rise in oil prices and weakening of domestic currencies vis-à-vis the US dollar together constitute a considerable deterioration in their
terms of trade. That said, subdued price increases in other areas have meant that the impact on consumers’ overall purchasing power
has been manageable so far. But as we had expected, for a majority of countries, the low inflation environment of 2017, which allowed
for considerable policy easing, is unlikely to return any time soon.
Overall, emerging market countries remain inherently vulnerable to the risk of capital outflows associated with tightening global
liquidity, as advanced economy central banks reverse quantitative easing measures. Escalating trade frictions further add to overall
uncertainty. Those with weak fundamentals and relatively shallow, but open, capital markets are particularly vulnerable. Thus, three
areas we identified in our previous reports continue to dominate the discourse on the cyclical outlook for the global economy: 1)
tightening global liquidity conditions associated with the reversal of monetary policies in major advanced economies after a decade
of exceptional easing; 2) worsening economic disputes, particularly between the US and China on a range of matters including trade
policy, industrial policy and investment policy; and 3) the oil price outlook.
Exhibit 3
G-20 real interest rates
%
2018 is calculated based on actual CPI and policy rate year-to-date.

Sources: Haver Analytics, Moody’s Investors Service
An escalation of the trade dispute between the US and China will dampen global growth
A key change in our global macroeconomic outlook since our last quarterly publication in May is that we now believe US trade tensions
with China are more likely to worsen this year, weighing on global growth in 2019. We also expect more restrictions on Chinese
acquisitions of firms in the US and Europe. Hence our base case now assumes that the US administration will go forward with some of
its proposed additional restrictions on imports from China, in addition to the 25% tariffs on $50 billion worth of imports and the steel
and aluminum tariffs currently in effect.1
In contrast, with respect to the EU, the recent agreement between US President Donald Trump and EU President Jean-Claude Junker
has at the very least increased the possibility of trade negotiations over an extended period. Similarly, we maintain our view that
NAFTA negotiations between the US, Canada and Mexico will continue, likely resulting in an updated, modernized agreement in 2019.
Similar to NAFTA negotiations, negotiations with the EU will likely proceed over an extended period. Notwithstanding the possibility
of periodic flare-ups in tensions, ongoing talks with EU and NAFTA partners make it more likely that the proposed tariffs on auto and
auto parts will remain on hold. We therefore do not include these in our base case. Of all the disputes surrounding trade, it is the trade
relationship between the US and China that is presently most at risk of a significant deterioration in 2018.
Because the US administration has remained focused on the country’s recurring trade deficits, we expect it to continue to explore
tariffs and other trade measures as tools to address the deficits. However, the imposition of tariffs will not reduce the US’ recurring
current account deficits. At a broader level, the US’ external deficits will persist for some time, mirroring the savings-investment gap.
Being a large open economy, the US will remain an attractive global investment destination, absorbing the world’s excess savings. This
is unlikely to change any time soon. On the savings side, rising fiscal deficits in the US limits the scope for the domestic savings rate to
rise. Instead, tariffs and other trade restrictions on imports from specific countries or of certain products will change the composition of
exports and imports, and shift trade flows between countries.
Most of the impact of the trade restrictions on economic growth will be felt in 2019. The magnitude of the macro impact will depend
crucially on the resilience of sentiment. Tightening of financial conditions through asset price and currency adjustment and a broader
hit to business and consumer confidence are now more likely than a few months ago.
All else equal, we expect current tariffs plus the implementation of 10% tariffs on $200 billion worth of US imports from China and
proportionate retaliation by the Chinese government to shave up to 0.3-0.5 percentage points off China’s real GDP growth in 2019.
However, such measures will likely be met with moderate fiscal policy and liquidity easing measures in China designed to offset most
of the growth effects. Recent assurances from the Chinese government that headline growth objectives will be achieved even in the
event of additional trade restrictions by the US support this view. In addition, potential further depreciation of the Chinese renminbi
(RMB) will in part offset the loss of competitiveness from higher tariffs. Thus we continue to forecast 6.6% real GDP growth in China
for 2018 and 6.4% for 2019.
As for the US, the underlying economic momentum remains very strong, with the economy adding more than 200,000 jobs a month
on average even with a historically low unemployment rate of 3.9% in July. We estimate that trade restrictions will shave off about
one quarter of a percentage point from real GDP growth to 2.3% in 2019, offsetting some of the strong momentum attributable to the
fiscal stimulus. Overall, at the macro level, the impact of 10% tariffs on $200 billion worth of imports may be seemingly manageable
for both the US and China. But individuals, firms, sectors and countries engaged in trade along global supply chains may still face
significant disruptions (see our Global Trade Monitor and our other research on the theme of rising trade tensions).
Additional tariffs on imports from China or on autos and auto parts present a material downside scenario for global growth
Our baseline forecasts do not currently account for the most recently proposed 25% tariffs on $200 billion worth of imports from
China or the 25% tariffs on autos and auto parts. The implementation of either would pose a large adverse shock through multiple
channels, and would signify a serious escalation in the trade dispute. At 10%, the impact of tariffs will likely be manageable for the
US economy, offset in part by exchange rate movements. At 25%, the tariffs on $200 billion worth of Chinese products will likely
result in significant price increases for a number of products consumed in the US. To the extent that the tariffs fall on capital goods,
producers will see a significant rise in their input costs. The implementation of these measures would signal a significant escalation in
the trade war and could have a lasting impact on both the US’ economic and diplomatic relations with China. A move in this direction
could be considerably damaging to global growth, not only through the global trade value chains, but also by injecting a high degree
of uncertainty, dampening investment and pulling down asset prices globally. In a stress scenario, a material fall in asset prices and a
significant hit to confidence, recession outcomes in the US are possible.
Tariffs at 25%, instead of 10%, will also have a significant negative impact on the export sector of the already slowing Chinese
economy. China’s exports to the US constitute 18% of total exports and around 3% of its GDP. The Chinese authorities have
considerable capacity to mitigate the adverse effects on its economy through the direct trade channel with fiscal policy. Still, at
the macro level, the impact of tariffs on the economy could be felt by privately-owned businesses, not just via trade, but also via
investment, output and employment. Knock on effects on private sector business sentiment, if investors feel more exposed to policy
uncertainty because of worsening diplomatic relations, presents additional headwinds to the rebalancing efforts in which the private
sector has an important role.
On the one hand, the impact of tariffs will reverberate across the global economy through the extensive value chains that span a
number of emerging market countries from Asia to resource exporters in Latin America. On the other hand, a concern for large markets
such as the EU or other emerging markets is that, faced with excess capacity, Chinese products will flood their markets depressing
prices and making it difficult for domestic firms to compete.
Exhibit 4 Exhibit 5
An escalation of the trade dispute risks dampening trade growth Global commodity prices
% change year-over-year 3-month moving average
World Trade Volume World Trade Volume: 3 Months moving average 110 110
6 105 105
5
100 100
4
YoY % Change
95 95
3
90 90
2
85 Primary Aluminum 85
1 Aluminum Alloy
Copper
80 Lead 80
0 Tin
Zinc
-1 75 75
2014 2015 2016 2017 2018 2019 Jan Feb Mar Apr May Jun Jul Aug
2018
Source: CPB World Trade Monitor Source: Financial Times/London Metal Exchange
An escalation of the trade dispute will additionally affect emerging market countries through the exchange rate channel, particularly
in case of countries with less liquid capital markets (see Exhibits 6-7). Weaker emerging market currencies vis-à-vis the US dollar will
exacerbate the inflationary impact of higher oil prices for some of these countries. Emerging market central banks, already faced with
downward pressure on their currencies because of tightening monetary conditions in the US and Europe, will be compelled to follow
tighter monetary policy at home.
Exhibit 6 Exhibit 7
Selected emerging market exchange rates Emerging Market Bond Index and EM ETF Volatility Index
Index [2018 January = 100]
EMBI Global Total Return Index (LHS)
180 180 CBOE EM ETF Volatility Index (RHS)
850 45
170 170
40
160 160 800
Argentina
150 Brazil 150 35
South Africa 750
140 India 140
Indonesia 30
130 Russia 130 700
Turkey
25
120 120
650
110 110 20
100 100 600

15
90 90
Jan Feb Mar Apr May Jun Jul Aug Sep 550 10
2018 2013 2014 2015 2016 2017 2018 2019
Source: Central Banks Official Exchange Rates Source: JP Morgan & Chicago Board Options Exchange
Crude oil price to remain elevated in the near term but moderate over the medium term
Our oil price outlook is informed by our view that with today’s drilling and services costs, oil prices in the $50-$55 per barrel range
are supportive for the vast majority of current and planned production. Thus we believe that over the medium term (3-5 year period),
oil prices will gravitate lower toward our medium-term $45-$65 per barrel price range. Eventually, higher drilling and services costs
could push fundamental prices closer to the top end of our $45-$65 per barrel range (see Exhibits 8-9). In the near term, however, a
number of factors that have led the Brent spot price to move above $70 per barrel (with the WTI at $3-$5 below Brent) will continue
to support elevated oil prices. Accordingly, we expect that the Brent spot price will average around $72 per barrel in 2018 and $71 per
barrel in 2019.2
Exhibit 8 Exhibit 9
Global oil spot prices August 2018 estimates for Brent and WTI spot prices
US$ US$
Brent WTI
Annual Average of Brent Annual Average of WTI
120
110
100 $99
$94
90
US$ / Barrel
80
70 $71
$66
60
$53 $54
50 $49 $51
$44
40 $43
30
20
2014 2015 2016 2017 2018
Source: Haver Analytics Moody's Investors Service medium term (3-5 year period) price range is $45-$65. (US$ per
bbl for Brent and WTI)
Source: Moody’s Investors Service
Oil spot prices are inherently volatile. On the supply side, a rise in US output is to a degree offsetting production cuts from OPEC.
Robust global growth is ensuring adequate demand. Numerous technical factors affect oil spot prices both positively and negatively.
Geopolitical risk and inconsistent production in countries like Libya and Nigeria, along with declining production in Venezuela, have
added upward pressure on the price of oil, more than offsetting the downward pressure from a stronger US dollar. Other transitory
events also play a part, such as the recent shutdown of the Syncrude facility in Canada or the strike by Norwegian oil workers. These
drivers are likely to be short-lived, but will contribute to volatility in the oil market. The reimposition of US sanctions on Iran also adds a
fair degree of uncertainty.
Selected forecast revisions

Growth forecasts for only a handful of countries have been revised in this August update relative to our May forecasts. We have raised
our 2018 growth forecast for the US and Mexico on account of robust performance in the second quarter and the stronger-than-
expected momentum. However, our baseline expectation that rising trade-related tensions between the US and China will weigh on US
growth with a lag, in 2019, has meant holding the US real GDP growth forecast for 2019 below consensus. On the other hand, we have
maintained our real GDP growth forecast for China. We expect the Chinese government to offset any drag on growth from external
factors with policy stimulus.
We have revised the growth forecast for Korea marginally by one-tenth of a percentage point because of headwinds from slowing
trade. However, Korea’s economic growth remains strong, as indicated by high frequency data, and in the near term will be supported
by the recently announced stimulus package.
Elevated oil prices, slowing trade growth amid mounting trade tensions and tightening financial conditions already weigh on economic
activity in many major emerging market countries. The resulting rise in risk aversion has led to a slowing of net portfolio flows to
emerging market economies in the second quarter of 2018, causing considerable adjustment in financial and currency markets.
As we said in our May report, repeated bouts of heightened financial market volatility and reversals of capital flows away from
emerging market countries are expected amid the reversal of easy global financing conditions. Given the mix of weak macroeconomic
fundamentals, loose monetary policy and economic dependence on foreign financing, it is not surprising that Argentina and Turkey
have been most vulnerable (or under most stress). Turkey’s economic policies in particular have contributed to a worsening of its credit
fundamentals, making its economy uniquely vulnerable.
Investors’ need for portfolio rebalancing has led to increased exchange market pressure in other countries as well. But the risk of a
wider disruptive contagion event engulfing other emerging market countries remains small, given relatively stronger fundamentals.
According to the Institute of International Finance, net capital flows to 19 emerging market countries, including Argentina, Brazil, Chile,
China, Colombia, the Czech Republic, Hungary, India, Indonesia, Korea, Mexico, the Philippines, Poland, Russia, South Africa, Thailand,
Turkey and Ukraine, slowed to $11 billion in the second quarter from $118 billion in the first quarter. Excluding China, this group saw
net outflows of some $2.0 billion in the second quarter (see Exhibits 10-11). We expect portfolio flows to emerging market countries to
remain volatile as monetary policy accommodation in advanced economies is gradually withdrawn. But other flows, including FDI and
bank flows, will remain relatively strong overall.
As we have argued before, challenging monetary policy decisions are in store, particularly for central bankers of recovering emerging
market economies faced with the trade-off of meeting inflation objectives by ensuring a degree of exchange rate stability without
compromising economic recoveries.
We have revised our real GDP growth forecasts for Brazil and Argentina down considerably for both 2018 and 2019. In both countries,
a combination of a challenging external environment and domestic weaknesses have hampered near-term growth prospects. We
have also slightly lowered our real GDP growth projections for South Africa on account of lackluster momentum. Among other G-20
economies, Turkey’s economy is rapidly deteriorating. We have therefore reduced Turkey’s growth forecasts for both 2018 and 2019.
There is, however, a fair amount of uncertainty and further downside risks to Turkey’s growth prospects, both short- and medium-term.
Exhibit 10 Exhibit 11
Net capital flows to emerging markets Nonresident portfolio capital flows
80 80 Non-Res Portfolio Equity Flow
Other EMs China Net Capital Flow
60 Non-Res Portfolio Debt Flow
70
INFLOW Total Non-Res Portfolio Inflows To Emerging Markets
Non-Res Portfolio Inflows to EMs (Bil. USD)

40
60
INFLOW
Net Capital Flow (Billion USD)
20
50
0
40
-20
30
-40
-23.5
20
-60
OUTFLOW
-80 10
-100 0
-120 -10
OUTFLOW
-140 -10.6
-20
2014 2015 2016 2017 2018
2014 2015 2016 2017 2018
Monthly data Monthly data
Source: International Institute of Finance (IIF) Source: International Institute of Finance (IIF)
In the following sections we discuss our growth outlooks for select G-20 countries.
US economy is at a cyclical peak as inflation and wage growth start to stir

The US economy continues to grow at a solid pace, fueling jobs growth of over 200,000 a month, even with a historically low
unemployment rate of 3.9%. In line with consensus expectations, the Bureau of Economic Analysis published the advance estimate
of second-quarter real GDP growth of 4.1% on an annualized basis and raised the first-quarter estimate up to 2.2%. Notably, with the
GDP deflator growing at 2.4% year-on-year, nominal GDP grew by 5.4% over the past year, the fastest pace since the global financial
crisis. Nominal growth reflects steadily strengthening revenue generation for businesses, which bodes well for continued job creation
and business investment.
Underlying the headline real GDP growth was a robust contribution from all major components of GDP (see Exhibit 12). Consumer
spending rose by 4%, business investment grew by 7.3% and net trade contributed 1.1 percentage points to growth on the back of
strong soya bean exports. We concur with the consensus view that the second-quarter performance will not be easily repeated in
subsequent quarters on a sustainable basis. We expect growth in the second half to remain above trend, albeit somewhat slower than
in the first half. We have accordingly raised the growth forecast for 2018 to 2.9%, from 2.7% previously.
Contributions to real GDP growth in the US US labor market conditions improved close to the two previous
peaks
Consumption Unempl+Margin Attach+Part Time Econ Reasons/CLF + Margin Attach
Investment
6% Civilian Unemployment Rate: 16 yr +
Net Exports
10% 10%
Gov't Consumption & Investment
5% Real GDP Growth
9% 9%
4.1%
8.3%
8% 7.9% 8%
4%
7% 7.0% 7%
3%
6% 6%
2% 5% 5%
4.6%
1% 4% 4.0% 4.0% 4%
3% 3%
0%
2% 2%
-1% 1% 1%
-2% 0% 0%
2014 2015 2016 2017 2018 2000 2007 2018
Source: Haver Analytics

Source: Haver Analytics
We believe that tariffs and other trade restrictions as well as rising uncertainty surrounding future trade policy will have an adverse
impact on business sentiment, investment decisions and growth in 2019 and beyond. We have therefore maintained our growth
forecast for 2019 at 2.3%. In the absence of a worsening trade dispute between the world’s two largest economies, we would have
also raised our 2019 growth forecast for the US economy by two-tenths of a percentage point on the basis of robust labor market
conditions (see Exhibit 13) and supportive fiscal policy. Even then, at 2.3%, the US economy will register solid growth in 2019 especially
considering capacity constraints associated with full employment.
Employers are already facing rising costs as the labor market continues to tighten (see Exhibits 14-15). The July print of the
Employment Cost Index (ECI) shows an increase of 2.9% over the past year. Rising labor costs will gradually generate greater pressure
on company margins, and eventually lead to higher prices. Rising inflationary pressures and rising interest rates will in turn slow growth
to more sustainable levels. Nonetheless in the very near term, continued job gains, firming nominal wage growth and modest inflation
in the range of 2%-3% will keep consumer spending growth at a healthy level over the rest of the year.
Another sign of confidence in the US labor market for upward wage US wage growth
pressure is rising compensation cost by firms to attain workers
ECI: Wages & Salaries Difference in wage growth of job switchers & stayers (RHS)
3%
ECI: Compensation Atlanta Fed: median wage growth
JOLTS: Quits Rate: Total Private (RHS) 5.0 1.5
4% 4.5
1.0
2.5%
6 Months moving average (%)

2% 4.0
YoY % Change
3% 0.5
Quit Rate
3.5
3.0 0.0
2%
2.9%
1%
2.5
-0.5
1%
2.0
-1.0
1.5
0% 0%
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
1.0 -1.5
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
Sources: US Bureau of Labor Statistics (BLS), Job Openings and Labor Turnover Survey (JOLTS)
Sources: US Bureau of Labor Statistics (BLS), Job Openings and Labor Turnover Survey (JOLTS)
With goods comprising only 20% of households’ consumption basket, the 10% tariffs on imports from China will have a modest, one-
time, impact on price levels in the US. Additionally, only a fraction of the tariff will be passed on to final goods prices because 1) the US
dollar appreciation will offset part of the impact of tariffs, and 2) domestic retail and distribution costs are added to fresh-off-the-boat
costs, and constitute a large fraction of final goods prices. Thus the tariff will fall on only a portion of the retail price for a large number
of consumer goods imported from China.
We expect rising labor costs to be the main driver of sustained inflation. We expect the headline CPI inflation to moderate toward the
end of this year, to 2.3% from 2.8% in June, as the transitory impact of higher oil prices fades. We expect core inflation, excluding oil
and food prices, to remain slightly over 2% for the rest of the year and moderate toward 2% by the end of 2019.
Against the backdrop of robust growth, labor market developments and inflation, we expect the Federal Reserve to increase the federal
funds rate by 25 basis points two more times this year and three times next year. Indeed, if economic momentum sustains above what
we currently anticipate and wage growth picks up meaningfully, the Federal Reserve could raise interest rates more rapidly.
We have not changed our view of the Federal Reserve’s monetary policy outlook in response to the change in our baseline assumption
on increasing protectionism. This is because even though we believe that ongoing trade tensions will weigh on growth in 2019, growth
forecasts reflect above-trend growth expectations that would lead to significant overheating if monetary policy tightening were to be
scaled back. The latest FOMC minutes reflect a concern among its members regarding risks stemming from trade policy uncertainty.
However, we do not believe that the committee will shy away from the current path of gradual normalization of interest rates at this
stage in the business cycle so long as growth, employment and inflation expectations are not materially derailed, as is the case with our
modest forecast revisions. However, it is possible that the Federal Reserve will halt the interest rate tightening cycle that is currently
underway, if the more disruptive measures such as 25% tariffs on autos or 25% tariffs on a significant share of imports from China are
implemented by the US government, given the threat they will pose to global asset prices and the world economy. In the absence of
the most disruptive trade risks, a likely scenario is that inflation would rise rapidly on the back of building wage pressures, leading the
Federal Reserve to tighten more rapidly in 2019.
China's growth will come at the cost of slower deleveraging efforts

China’s economic growth slowed in the second quarter to 6.7% year-over-year, from 6.8% in the first quarter as we had expected,
primarily because of the impact of deleveraging measures undertaken by the government to curb loan growth. The continued
slowdown in fixed asset investment (see Exhibit 16) is consistent with the tightening measures designed to help the economy’s
structural transition to an increasingly consumer and services oriented economy.
As explained earlier, we have maintained our growth forecasts for the Chinese economy. We expect it to expand at 6.6% this year
followed by 6.4% in 2019. While maintaining some policy emphasis on deleveraging and de-risking, the government has displayed
a preference for maintaining robust GDP growth, as shown by a series of measures that point to more accommodative fiscal and
monetary policy in the face of downward pressures from slower credit growth and weaker external demand amid US trade policy
uncertainty. Looking toward 2019 and beyond, we believe that the government will continue to support GDP growth even as trade
tensions continue to heat up, and possibly at the cost of slower deleveraging and rebalancing of the economy.
Efforts on part of the Chinese government and central bank to facilitate deleveraging, alongside structural rebalancing, while
ensuring robust headline growth, has entailed a mix of policies. On the one hand, there is an active clampdown on certain activities
including interbank funding, wealth management products and off-balance-sheet bank activities. On the other hand, China’s overall
monetary policy stance has become more accommodative recently, likely with the aim of ensuring that the deceleration in growth
is measured and orderly. Steps undertaken by the People’s Bank of China to provide liquidity in the banking sector include cuts in
the required reserve ratio (RRR), the latest of which the PBOC estimated would inject RMB400 billion ($58 billion) in the banking
system, and an injection of RMB502 billion ($73 billion) into its banking system through lending facilities. In addition, the government
had adopted a number of fiscal measures, including: urging local governments to speed up disbursal of unused fiscal revenue;
directing financial institutions to provide adequate lending to local governments’ off-budget financing vehicles so that compliant
projects are not delayed; additional tax cuts to the tune of RMB6.5 billion ($950 million) for corporate investment in research and
development; and, accelerated issuance of special bonds to finance local government infrastructure projects in transport, oil and gas,
and telecommunications. We view the recent RMB weakening against the US dollar in this context of policy easing.3
Continued slowdown in fixed asset investment in China China PMIs also show slower growth in production and new orders
Purchasing Manangers Index, (Index, SA)
PMI New Orders Index, (Index, SA)
35% 55
Contraction (below 50) | Expansion (Above 50)
30%
Year over year % Change
54
25%
20% 53
15%
52
10%
51
5%
0% 50
2008
2010
2012
2014
2017
2009
2011
2013
2015
2016
2018
Jan Mar May Jul Sep Nov Jan Mar May Jul
2017 2018
Source: Haver Analytics Source: Moody's Analytics
Solid economic growth in the euro area

Real GDP growth in the euro area slowed modestly to 2.2% year-on-year in the second quarter of 2018, following 2.5% growth in the
first quarter, in line with our expectations. On a quarterly basis, the economy grew by 0.4% in the second quarter, as in the first quarter.
All indicators including industrial production, the purchasing manager's index (PMI), retail sales and sentiment have softened slightly
from historical highs since the beginning of the year, but remain robust. Accelerating lending growth to the nonfinancial sector and
stable lending to the household sector show that the underlying drivers of economic expansion remain intact, supported by robust
industrial activity and consumer spending. Manufacturing sector output picked up in the second quarter with industrial production
growing by 2.4% year-on-year in May, compared to 1.7% in April. The PMI has declined since the beginning of the year but appears to
have stabilized at a healthy level of around 55 (a PMI above 50 indicates expansion, see Exhibit 18).
Euro area PMIs have declined, but indicate solid ongoing expansion Euro area sentiment indicators have softened, but remain positive
United States Euro area Japan 50%
Global EMs Euro Area Germany
Contraction (Below 50) / Expansion (Above 50)
40%
60
30%
20%
55 10%
0%
-10%
50
-20%
-30%
45 -40%
2014 2015 2016 2017 2018 2011 2012 2013 2014 2015 2016 2017 2018
Source: Haver Source: Haver, SENTIX GmbH
Germany remains the main growth engine in the euro area. The economy grew by 0.5% quarter-on-quarter (2% year-on-year) in the
second quarter, up from 0.4% in the first quarter, driven by domestic demand. The French economy grew at slower quarterly pace at
0.2% in both the first and second quarters, roughly 2% growth in the first half, over the first half of 2017. We expect a similar pace in
the third quarter followed by some acceleration in the fourth quarter because of stronger household consumption helped by cuts in
personal income tax and contributions to unemployment insurance. Economic activity in Italy eased slightly in the second quarter to
0.2% (1.1% year-on-year) compared with 0.3% quarterly growth (1.4% year-on-year) in the first three months of the year. Thus despite
a slowing from 2017, major euro area economies (with the exception of Italy) are growing at a solid pace. A common factor exerting a
drag on the economies is slower trade momentum. Looking forward, continued labor market gains in all of the economies will continue
to support solid domestic demand growth.
Given weaker than expected momentum, we have lowered our annual growth forecast for Italy to 1.2% in 2018, from 1.5% and 1.1% in
2019 from 1.2%. In the case of France, we have also revised our growth forecast for 2018 to 1.8% down from 2% to account for weaker
than expected growth in the first half of this year. We continue to forecast 2019 real GDP growth of 1.8% for the French economy. Our
growth projections for Germany remain unchanged at 2.2% this year, followed by 1.7% growth in 2019.
With gently firming but benign inflation, the European Central Bank’s (ECB) monetary policy will remain supportive. As per our
expectations, the ECB Governing Council has stated an end to additional asset purchases under the QE program at the end of this year
and that it will keep interest rates on hold through the summer of 2019. Assuming the current expansion continues, we have pushed
our forecast for the first ECB policy rate hike by one quarter to the third quarter of 2019. We forecast real GDP growth of 2.1% in 2018
and 1.8% in 2019 for the euro area as a whole.
A key downside risk to euro area growth forecasts stems from trade relations with the US, although fears of an all-out trade war have
settled down after EU President Junker’s visit to Washington in July. That said, euro area exports to the US only totaled about 2.5%
of GDP in 2017. Thus, while the US imposition of tariffs on imports from the EU could be acutely painful for some sectors, it would be
manageable overall.
Japan's growth rebounded after first-quarter contraction

We have reduced our real GDP growth forecasts for Japan at 1.1% in 2018, from 1.3%, and to 1.0% in 2019 from 1.1%. In the second
quarter, Japan’s economy rebounded, growing by 0.5% (1.9% annualized) over the previous quarter, after contracting by 0.2%
(-0.9% annualized) in the first quarter. In year-on-year terms, the economic growth was flat 1% in both quarters, weaker than we
had previously expected. Second-quarter data indicates that consumption spending has bounced back, but not enough to offset the
first-quarter slump. Private investment remains strong. However, external demand subtracted 0.1 percentage points from growth.
We expect that the intensification of trade tensions will weigh on investment decisions going into 2019. The planned consumption
tax increase will also weigh on growth in 2019, even though Prime Minister Shinzo Abe has communicated a willingness to use other
stimulus measures to offset adverse impacts on spending. We see further downside risks associated with the US administration’s
proposal to raise tariffs on autos and auto parts, which would dampen exports, business confidence and investment spending
significantly.
We expect inflation to remain subdued below the Bank of Japan’s (BOJ) target and monetary policy to remain highly accommodative
for some time. The BOJ cited concerns about financial stability risks when communicating that it would maintain the current policy
of yield curve control, while allowing the 10-year yield to fluctuate slightly around the 0% target. We view this announcement as
incorporating a degree of flexibility into the policy framework, and not as a reversal of the BOJ’s policy stance. Our baseline forecast
continues to assume broad-based financial stability.
UK growth prospects linked to Brexit outcome

Economic activity recovered in the second quarter, growing by 0.4% (1.3% year-on-year), up from 0.2% (1.2% year-on-year) in the
first quarter of 2018. The 1.2% growth in the first half of the year over the first half of 2017 is in line with our expectations. We forecast
tepid real GDP growth of around 1.3% in 2018 for the UK, followed by 1.6% in 2019.
Poor performance in the first quarter was in part driven by the impact of inclement weather and other transitory factors on the
construction and distribution sectors. But the underlying economic momentum has also continued to steadily weaken since the June
2016 Brexit vote. Growth in business fixed investment remains weak. Private consumption growth has so far remained muted because
of subdued real disposable income. However, in the near term, a record employment rate of 75.7%, moderating inflation and stable
nominal wage growth should lend support to households’ purchasing power and steady consumption growth.
The fall in inflation from 3.0% in January to 2.4% in June has been broadly in line with our forecasts. We expect the inflation rate to
continue falling in the second half of the year to 2% by year-end, as the impact of higher energy prices fades from the headline price
index.
The Bank of England’s (BOE) monetary policy committee voted unanimously to raise the policy rate by 25 basis points to 0.75% on 2
August, citing evidence of a recovery from the soft patch in the first quarter and the expectation of strong wage growth. We expect the
BOE to raise the policy rate again only in mid-2019. The central bank also indicated its estimate of the neutral or equilibrium interest
rate, consistent with trend growth and stable inflation, to be 2%-3%. We expect the policy rate to reach this range only in 2022.
With regard to Brexit negotiations, our forecasts are based on the assumption that some form of an agreement will ultimately be
reached with the EU, which would substantially mitigate the negative economic impact of leaving the European Union. But continued
difficulties in the negotiations suggest that the probability that the UK government will be unable to secure a trade deal has increased.
While the EU and UK could find a solution in the coming months, there is now less time remaining to avert a “no deal” scenario (see
our Brexit Monitor).4
External headwinds weigh on Brazil's growth forecasts

Economic activity in Brazil suffered a major setback because of nationwide strikes in May. As a result, economic activity contracted
by 3.3% over one month from April. While the economy rebounded in June, incoming data including retail sales, PMI and industrial
production suggest that the broader recovery is losing steam. As per our expectations, inflation, both headline and core, has started
to rise. The headline inflation rate jumped to 4.4% in June from 2.9% in May and core inflation also rose by 50 basis points to 3.3%.
Inflation will likely firm further because of pass-through from the recent depreciation of the real. Even though the Brazilian central
bank has held the Selic rate flat at 6.5% since March, interest rates have risen across the yield curve since April. Financial markets came
under pressure from April to June as capital inflows dried up. These developments will likely weigh on the strength of the recovery.
Rising inflation will hurt consumer spending by eroding real wages while higher interest rates will dampen investment spending.
Uncertainty over election outcomes and policies is an additional source of risk. We have cut our real GDP growth forecasts for Brazil to
1.8% in 2018 and 2.0% in 2019, from 2.5% and 2.7% respectively.
The Brazilian central bank has so far resisted pressure to raise the policy rate, instead undertaking reserve interventions or, alternatively,
allowing the real to depreciate in the face of financial market pressure. However, as US interest rates continue to rise and given the
high degree of exchange rate pass-through, monetary policy tightening is inevitable under the current inflation targeting framework.
Otherwise, the Brazilian central bank risks losing control of inflation expectations that have gradually declined over the last few years.
Recession inevitable in Argentina

We expect Argentina’s real GDP data for the second quarter of this year to show a contraction because of the combined impact of the
severe drought on soybean and corn production and the currency crisis starting in April. By contrast, real GDP grew by 1.1% quarter-
over-quarter in the first quarter of 2018, or 3.8% year-on-year. We now expect Argentina's economy to contract by 1% in 2018.
Recovery will be slow. We forecast 1% real GDP growth in 2019.
With normal weather forecast for the rest of the year, agricultural production will likely bounce back. But high inflation, tighter financial
conditions and contractionary fiscal policy will continue to depress growth for some time. Argentina’s commitments to the IMF, in
return for the three-year $50 billion standby arrangement, include a tight monetary policy with the objective to bring the inflation rate,
which reached 29.5% in June, to single-digits by the end of 2021, in addition to achieving a primary balance by 2020.
With the Argentine peso having fallen by some 27% since April, we expect inflation to rise further before falling by the end of 2019
toward 20%. The central bank is targeting inflation of 17% by year-end 2019, which may prove difficult despite the rise in the policy
interest rate to 40% because of the deeply entrenched high inflation expectations that prevailed even before the currency crisis.
Spending cuts required to attain a primary balance by 2020, will weigh on growth in 2019.
In addition to the uncertainty inherent in the adjustment process that follows a large negative shock, Argentina’s growth outlook is
clouded by political and policy uncertainty. The next presidential elections are scheduled for October 2019. President Mauricio Macri’s
popularity has been dented by the currency crisis and the IMF agreement. Thus postelection policy continuity is less certain.
South Africa's economy continues to underperform relative to potential

We had raised our real GDP growth projections for South Africa in May with the expectation that the economy will start to recover
faster because of a restoration of confidence and optimism after the election of Mr. Cyril Ramaposa as the new President in February.
However, growth indicators for the second quarter suggest continued inertia following the first quarter contraction of 2.2% on a
quarterly annualized basis. We have thus revised down the 2018 real GDP growth forecast for South Africa to 1.5%, from 1.6%. We
have also revised our real GDP growth forecast for 2019 to 1.8% from our previous projection of 2.1%. While we expect that economic
momentum will gradually accelerate, the pickup will likely be moderated by continued fiscal consolidation, particularly the rise in the
rate of the value-added tax (VAT) to 15% from 14%, fuel duties and tightening monetary conditions.
The South African Reserve Bank (SARB) cut the benchmark rate by 25 basis points to 6.5% in March 2018 consistent with weak growth,
moderate inflation and appreciation of the rand earlier in the year. But like other emerging market central banks, ongoing monetary
policy tightening in the US limits the ability of the SARB to pursue further easing without risking further depreciation of the domestic
currency, and subsequent pass-through to inflation. Thus we expect that the central bank will follow a tighter monetary policy, to
maintain a reasonable interest rate differential with the rising US federal funds rates and to manage downward pressure on the rand.
Renewed external pressure on Turkey

Turkey’s currency is under renewed pressure as international investor sentiment has soured over the state of Turkey’s economy and
the policy mix. Turkey’s extremely strong output growth in the first quarter of 2018 of 7.4% has come at the cost of rising inflation
and widening current account deficits. The fiscal-monetary policy mix that prioritized growth has caused overheating in the economy.
Weakening of the Turkish lira and high oil prices perpetuates the vicious cycle.
Worsening credit conditions and declining confidence are likely to have a very negative impact on the Turkish economy, which we
reflected in a revision to our growth and inflation forecasts for 2018 and 2019. We now expect real GDP growth to drop to 1.5% in
2018 and 1.0% next year, after 7.4% last year. High inflation and the expected slowdown in lending will curtail private consumption
because of the negative impact on households’ purchasing power. Business confidence has slipped since April. The PMI has remained in
the contractionary territory, below 50, over the last four monthly readings. Retail sales fell by 1.3% in the month of May.
Since April, the central bank has increased the new policy rate (the one-week repo rate) by 500 basis points to 17.75%. With renewed
pressure on the lira and inflation still rising, we expect that the central bank will continue to raise interest rates. However, in our view,
the rate hikes so far do not reflect a decisive monetary policy stance to thwart inflationary pressures, restrain inflation expectations
and restore policy credibility. Thus we expect that worsening inflationary pressures will only strengthen in the short term, further
undermining the credibility of the Turkish central bank's inflation targeting framework.
Growth largely resilient to external pressure in India

We expect the Indian economy to grow around 7.5% in 2018 and 2019.
Economic activity grew by 7.7% in the first quarter of 2018. High frequency indicators suggest a similar outturn for the second quarter.
Growth is supported by strong urban and rural demand and improved industrial activity. The PMI and the index of 8 core industries
shows robust activity in the industrial sector. A normal monsoon together with the increase in the minimum support prices for kharif
crops, should support rural demand.
Thus, despite external headwinds from higher oil prices and tightening financing conditions, growth prospects for the remainder of the
year remain in line with the economy’s potential.
In July, the Reserve Bank of India (RBI) raised the benchmark repo rate by 25 basis points for the second time in two months to 6.5%.
Two concerns behind the tightening cycle are rising core inflation and vulnerability to tightening external financial conditions. Retail
inflation in India has risen as per our expectations since mid-2017, but remains stable around 5%. But core inflation has moved up
in recent month to 6.2%. There are a number of factors influencing the headline inflation rate in both directions, most of which
are transitory. The run up in energy prices over the past few months will raise headline inflation temporarily. The impact on food
inflation from increased procurement prices to farmers, will be mitigated somewhat by the expected rise in farm output because of a
good harvest. Most importantly, upside to inflation comes from strengthening demand, which is reflected in rising core inflation. We
therefore expect the RBI to continue on a steady tightening path into 2019.
Solid growth in Indonesia amid external headwinds

The Indonesian economy has remained stable, growing at around 5% for the last three years. Economic activity expanded once again
by 5.3% year-on-year in the second quarter, following 5.1% growth in the first quarter. We expect real growth to remain flat, averaging
around 5.2% in 2018 and 2019. We expect GDP growth to be driven mainly by robust investment in the resource sector and public
infrastructure projects, while consumer spending and export growth will likely provide only limited support.
As per our expectations, the Bank of Indonesia has embarked on a tightening cycle. The policy rate was raised in May and June by a
total of 100 basis points to 5.25%, partially in response to tightening external conditions, to stem capital outflows and stabilize the
rupiah. At 3.2% in July, the inflation rate remains stable and is well within the central bank’s target of 2.5%-4.5%. But we believe that
the Bank of Indonesia will continue with calibrated policy tightening aimed at minimizing the destabilizing effects of volatile capital
flows on the currency as global financing conditions continue to tighten.
Moody's related publications

Cross-Sector
» Global Macro Outlook: 2018-2019 (May 2018 Update): Near-term global economic outlook remains strong, but downside risks rise
to the surface, 30 May 2018
» Global Trade Monitor (July 2018): Escalation of global trade tensions becomes the baseline expectation, 31 July 2018
» Moody’s Financial Monitor: Current conditions mask risks that will crystallize when the cycle turns, 16 July 2018
» Corporates - Global: High corporate leverage signals future credit stress even as the default rate remains very low, 24 May 2018
Trade
» Government of Germany: Auto tariffs would dampen German growth somewhat, but have no material credit implications for the
sovereign, 30 July 2018
» Retail & Business Products –US: China tariff would be credit negative for furniture & home goods retailers, 23 July 2018
» Trade -US and Mexico: FAQ on NAFTA Renegotiation, US-Mexico Trade and US Economy, 29 June 2018
» US: Looming US restrictions on technology transfer to China will moderately disrupt certain US industries, 25 June 2018
» Automotive —Global: Potential US tariffs on imported vehicles, parts credit negative for most of industry, 25 June 2018
» US and China:China tariff proposal has mixed credit implications for US sectors, 10 May 2018
» Trade - China: Tech most exposed to US tariffs; supply chains to amplify effect on other sectors, 11 April 2018
» US and Canada: NAFTA exit would weigh on states and provinces more than national economies, 15 March 2018
» Trade -US: Steel and aluminum tariffs would hit heavy manufacturing sector the hardest, 9 March 2018
» Sovereign - Global: US tariffs, if they prompt more trade restrictions, will hurt sovereigns globally, 7 March 2018
» Steel - Europe: US import tariff is credit negative for the European steel industry, 2 March 2018
» Aluminum - US:Import tariffs to affect US aluminum companies differently, depending on product chain position, 1 March 2018
Topic pages
» The Big Picture 2018 Global Credit Themes
» Global Macro-Economic & Financial Risk Analysis
» Rising Trade Tensions
To access any of these reports, click on the entry above. Note that these references are current as of the date of publication of this
report and that more recent reports may be available. All research may not be available to all clients.
Endnotes
1 Escalation of global trade tensions becomes the baseline expectation, 31 July 2018.
2 Crude oil prices to remain elevated in the near term but moderate over the medium term, 22 August 2018.
3 See: Easing poses limited fiscal risk, but suggests policy trade-offs are starting to bite, 27 July 2018.
4 For monthly updates on economic and credit implications of Brexit developments, see our Brexit Monitor.
© 2018 Moody’s Corporation, Moody’s Investors Service, Inc., Moody’s Analytics, Inc. and/or their licensors and affiliates (collectively, “MOODY’S”). All rights reserved.
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REPORT NUMBER 1136334
Analyst Contacts
Colin Ellis +44.20.7772.1609 Marie Diron +65.6398.8310

MD-Credit Strategy MD-Sovereign Risk
colin.ellis@moodys.com marie.diron@moodys.com
Michael Taylor +65.6311.2618 Atsi Sheth +1.212.553.7825
MD-Credit Strategy MD-Credit Strategy
michael.w.taylor@moodys.com atsi.sheth@moodys.com

Global Macro Outlook 8 2018 Moody

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CROSS-SECTOR

OUTLOOK Global Macro Outlook: 2018-19 (August 2018 Update)

THIS REPORT WAS REPUBLISHED ON 27 AUGUST 2018 WITH AN UPDATE TO EXHIBIT 9.

2018 is calculated based on actual CPI and policy rate year-to-date.

100 100 600

Selected forecast revisions

Non-Res Portfolio Inflows to EMs (Bil. USD)

US economy is at a cyclical peak as inflation and wage growth start to stir

Source: Haver Analytics

6 Months moving average (%)

China's growth will come at the cost of slower deleveraging efforts

Solid economic growth in the euro area

Japan's growth rebounded after first-quarter contraction

UK growth prospects linked to Brexit outcome

External headwinds weigh on Brazil's growth forecasts

Recession inevitable in Argentina

South Africa's economy continues to underperform relative to potential

Renewed external pressure on Turkey

Growth largely resilient to external pressure in India

Solid growth in Indonesia amid external headwinds

Moody's related publications

» The Big Picture 2018 Global Credit Themes

» Global Macro-Economic & Financial Risk Analysis

» Rising Trade Tensions

REPORT NUMBER 1136334

Colin Ellis +44.20.7772.1609 Marie Diron +65.6398.8310

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