US: Catalyst for tighter Fed policy – Goldman Sachs

Research Team at Goldman Sachs, notes that although 2016 has been a disappointing year overall, global growth is now accelerating to the top of the 3%-3½% range that has prevailed throughout the past five years. 

Key Quotes

“The main reason is the swing in the financial conditions impulse from sharply negative to modestly positive, both in the US and in parts of the emerging world.”

“US President-elect Donald Trump and the Republican-led Congress are likely to pass a fiscal stimulus package, which could provide a further temporary growth boost starting in mid-2017.  However, aggressive implementation of Trump’s trade and immigration policies would likely weigh on growth.”

“While Trump’s proposed policies have ambiguous effects on growth, they are likely to reinforce the gradual upward move in inflation that is already underway, as output and employment are now close to potential.  Moreover, we remain skeptical that the equilibrium interest rate has fallen as much as widely believed. We therefore still expect the Federal Reserve to raise the funds rate substantially more than implied by market pricing.”

“Tighter Fed policy is likely to put further upward pressure on global long-term rates.  Faced with significant slack and low core inflation, the ECB will try to insulate itself from the resulting tightening in financial conditions with an extension of its asset purchase program. The BoJ meanwhile will focus on the implementation of its yield control policy. Greater interest rate divergence should put continued upward pressure on the dollar.”

“The risks to our baseline forecast are skewed to the downside. First, much remains unclear about the economic policies of the incoming Trump administration, and the positive initial market reaction could reverse if the policy mix looks more unfavorable than now widely assumed.  Second, Europe could reemerge as a source of political risk, with the French election at the top of the list of concerns.  Third, a stronger dollar could lead to renewed pressure on emerging markets, especially China.”