Solid growth, faster inflation and stimulus in China: JP Morgan explains why major central banks are about to turn hawkish

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  • While financial markets are trying to send a signal to central bankers to take their foot off the monetary policy brakes, especially at the US Federal Reserve, JP Morgan doesn’t think policymakers will listen on this occasion as they have in the past.
  • It expects the global economy will grow 2.9% next year, helping to push core inflation, and policy rates, higher.
  • Of note, it sees the Federal Reserve hiking four times next year, more than the three seen by the median FOMC forecaster and well above the one-and-a-bit currently being priced in by financial markets. The bank also sees the ECB and BoJ pursing policy normalisation in interest rates.
  • A protracted trade war between the United States and China, and the likelihood of Chinese stimulus, is central to its call for above-trend global economic growth.

While financial markets are trying to send a signal to central bankers to take their foot off the monetary policy brakes, especially at the US Federal Reserve, JP Morgan doesn’t think policymakers will listen on this occasion as they have in the past.

Despite the threat posed by the the trade war between the United States and China, JP Morgan is forecasting that major central banks won’t be swayed by recent market volatility, choosing instead to tighten or normalise policy settings next year faster than almost everyone currently expects.

“Above-potential developed market growth and a stable China drive our forecast that developed market central banks deliver more tightening than markets currently anticipate,” says Bruce Kasman, David Hensley and Joseph Lupton, senior members of JP Morgan’s global economics team.

“Our baseline forecast judges the fundamental backdrop as healthy.

“Income is growing in a balanced manner, credit is flowing relatively easily, and fiscal and monetary policies remain supportive.

“We thus anticipate global GDP expands 2.9% in 2019, and that this sustained above-potential growth pushes core inflation and policy rates higher.”

JP Morgan

Rather than pausing or slowing the current pace of policy tightening seen this year, and despite an expectation the US economy has already passed its cyclical peak, JP Morgan says the Federal Reserve will continue the pattern of hiking its funds rate once a quarter, every quarter, in 2019.

“For the Fed, which we anticipate will hike four times next year, the sufficient conditions for this outcome is an expected fall in the US unemployment rate to 3.3% by the December quarter next year and financial market stability,” Kasman, Hensley and Lupton say.

Four times, more than the median FOMC projection of three hikes offered in September and well above current market pricing that is looking for barely one.

It also expects that a solid global economy will see both the European Central Bank (ECB) and Bank of Japan (BoJ) pursue a normalisation in monetary policy settings.

“For the ECB and BoJ, it is the expected upward trajectory of core inflation that will eventually prompt the start of gradual normalisation in rates,” the trio say.

“We expect recent disruptions in Euro area and Japanese industry to fade, promoting a growth rebound that offsets moderation in US growth toward 2%.”

If it sounds like a hawkish outlook, that’s because it is.

As such, Kasman, Hensley and Lupton say the risks to their views are to the downside.

“With geopolitical threats still present and our expectations for China stabilisation and a Euro area rebound yet to materialise, the risks to our 2019 outlook are skewed to the downside,” they say.

The bank, like many other forecasters, doesn’t expect the trade dispute between the United States and China will be resolved anytime soon, an outcome it says is actually crucial to its baseline view for solid global growth.

“We forecast that the US imposes an additional 25% tariff on virtually all goods imports from China early next year. This will drag materially on activity in China and could accelerate the decline in global business confidence now underway,”Kasman, Hensley and Lupton say.

“Our outlook assumes that China is delivering sufficient policy stimulus to offset much of the drag from tariffs, stabilising its GDP growth at about 6%.”

Despite the downside risks posed to the global economy from the trade dispute, the trio describe the risk of recession as next year as not “unusually high”.

“Based on MSCI data, the developed market corporate profit margin has surged to its highest level of the expansion and is now back at the peak of the 2000s expansion,” they say.

“At the same time, real policy rates in developed markets remain negative.

“Margin pressures look likely to emerge in the coming year as wage inflation is moving higher, but they are likely to build slowly and will likely become a material threat no earlier than 2020.”

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