The world economy will witness modest growth in the next few years but it could be derailed by financial and policy instability, according to the Organisation for Economic Cooperation and Development.
“Global GDP growth is projected to increase, rising from just under 3% in 2016 — the slowest pace since 2009 — to 3.3% in 2017 and around 3½ per cent in 2018,” the OECD said in its interim economic outlook, released on Tuesday.
However, the “disconnect between financial markets and fundamentals, potential market volatility, financial vulnerabilities and policy uncertainties,” could derail growth, it warned.
The organisation went on to explain each of these risks further.
“Equity valuations have increased significantly further in many major markets over the past six months, despite the large rise in nominal interest rates and with long-term nominal and real GDP growth expectations based on consensus forecasts barely changed,” it stated.
The S&P 500 has rallied more than 8% since September but has recently begun to flash some warning signs. Declining volumes, a mismatch between volatility expectations and economic uncertainty, and a flattening yield curve are among the signs the stock market rally could be nearing an end.
Additionally, “financial market expectations imply that a large divergence in short-term interest rates between the major advanced economies will open up in the coming years,” OECD warned. “This raises the risk of financial market tensions and volatility, notably in exchange rates, which could lead to wider financial instability.”
The strength of the US dollar — owing to expectations of higher growth and multiple rate hikes — has highlighted risks facing emerging economies. Many even worry about a repeat of 2013, when tightening by the US Federal Reserve caused disruptive capital outflows from emerging economies.
“Significant financial vulnerabilities arise from the overreliance on monetary policy in recent years,” the outlook stated, “which has led to an extended period of exceptionally low interest rates, rising debt levels in some countries, elevated asset prices and a search for yield.”
The OECD stated that “falling trust in national governments and lower confidence by voters in the political systems of many countries can make it more difficult for governments to pursue and sustain the policy agenda required to achieve strong and inclusive growth.”
Uncertainty over economic policy has skyrocketed since Brexit and the US election, but markets have rallied conveniently ignoring the potential risks. The upcoming elections in France, Germany, and Netherlands also pose the risk of a further populist uprising in Europe.
It is worth noting that OECD’s projected growth outlook is still below pre-crisis levels. “While the modest pick-up is welcome, it would still leave global GDP growth below the historical average of around 4% in the two decades prior to the crisis,” the OECD said.