Merrill Lynch launches 10 global economic forecasts for 2018

BofA Merrill Lynch Global Research on Tuesday issued a bullish global economic outlook for 2018, predicting 10 macro calls for the year ahead.

1. The S&P 500 Index continues to rise. The Standard and Poor's 500 Index is expected to reach 2800 by the end of next year. Earnings are expected to grow six percent based on a 2018 EPS (Earnings Per Share) forecast of 139 U.S. dollars.

2. Solid global economic growth. Real global GDP (Gross domestic product) is forecast to grow to a solid 3.8 percent, up slightly from 3.7 percent in 2017. Above-trend growth is expected in most major economies, with the Euro area maintaining a growth trajectory in 2018 and 2019 of around two percent and Japan remaining firmly above trend, with nearly 1.5 percent growth over the same time period. In aggregate, the emerging market economies are expected to grow nearly five percent in 2018, with China growing 6.6 percent.

3. Steady U.S. economic growth. U.S. GDP growth of 2.4 percent is expected in 2018, up from 2.2 percent in 2017, but capped by low productivity gains and a slower pace of hiring. The U.S. unemployment rate should drop to 3.9 percent in 2018, and a tightening labor market will likely allow inflation to pick up.

4. Inflation is back on radar. Inflation is expected to rise in the U.S., with core inflation reaching 1.8 percent at the end of 2018 and two percent at the end of 2019. Both wage and price inflation also should trend higher, with wage inflation potentially being the most important factor for the stock market in 2018 via margin pressure and credit spreads. Inflation should also increase in China and emerging Europe.

5. Emerging Markets (EM) move lower. Higher U.S. rates, a higher U.S. dollar and ECB (European Central Bank) tapering mean investors will need to be more selective in emerging market bonds and equities, which outperformed in 2017. Total credit returns of 3.2 percent are expected for EM corporates, 1.9 percent for EM investment grade and 5.4 percent for EM high yield.

6. Monetary fiscal policy points to higher rates. The market may be underpricing the risk that U.S. tax reform may be more impactful than expected. Should the market begin to appreciate the implications of tax reform, U.S. rates could make a significant move higher in the first quarter, adding inflation pressure in emerging markets.

7. Higher foreign exchange volatility. The U.S. dollar is expected to rally in the first quarter, supported by rising U.S. interest rates and potential repatriation flow occurring as a result of tax reform. Three key triggers could lead to higher foreign exchange volatility: central bank regime change associated with exit from quantitative easing, a reassessment of carry-seeking behavior, and a repricing of geopolitical risk premium. The dollar index is expected to reach 97.00 in early 2018.

8. Modestly constructive on commodities. While higher U.S. interest rates and a strong U.S. dollar could act as a headwind to commodities, robust global demand and tight supplies should see Brent crude oil rise to 70 dollars a barrel by mid-year. Among precious metals, there is limited upside to gold in 2018, with prices expected to reach 1,326 dollars per ounce.

9. Credit spreads tighten; disappearing supply. Fundamental trends in the credit markets are divergent, and there continues to be no single global credit cycle. U.S. credit spreads are expected to tighten in the first half of 2018 as excess demand conditions prevail, and then to give that back in the second half. Another year of spread compression also is expected in Europe on corporate bond QE (Quantitative easing) and negative rates.

10. Global Investment Strategy. Stocks are expected to outperform bonds for the seventh consecutive year in 2018, a track record not seen since 1928. BofA Merrill Lynch investment strategists are bullish on stocks, bearish on bonds, long U.S. dollar, and long on volatility.

    "Investors are approaching the new year with a Goldilocks mentality, expecting strong growth, low inflation and benign central bank policy. We are generally optimistic, expecting continued above-trend economic growth and modest inflation in most market," said Ethan Harris, head of BofA Merrill Lynch Global Economics.

"We also see three important downside risks on the horizon: politics, trade protectionism, and a larger-than-expected rise in inflation," he added.

(ASIA PACIFIC DAILY)