Making sense of an upside growth surprise

The U.S. tax overhaul and higher expected federal spending point to faster growth just as the expansion enters its ninth year. This represents a sea change from U.S. fiscal policy’s long drag on growth and bodes well for the synchronized, global expansion.

We expect the mix of corporate tax cuts, immediate capex expensing and higher federal spending to add 0.8 percentage point to 2018 U.S. real gross domestic product (GDP). This fiscal boost is the biggest in nearly a decade, as the chart below shows, and should help cement the inflation comeback.

We see scope for the Federal Reserve to lift rates four times this year rather than the three it has signaled—still a gradual pace. We estimate the U.S. cycle can power on for at least two to three more years. That brings the cycle’s recessionary tipping point forward by about a year. If overheating pressures are contained, the expansion could press on for longer, in our view. More U.S. growth spilling abroad could underpin the global expansion, implying less domestic overheating.

It’s a small world after all

Economies can run beyond potential for long stretches before peaking, especially when growth is just above trend, our research on economic cycles finds. Plus, some spare capacity persists globally, particularly in Europe. The global economy has never been so integrated at this point of an expansion, as we detail in Heating up, slowly, with world trade now making up about 50% of global GDP.

This lingering global slack should help moderate U.S. overheating and underpin the expansion, as U.S. stimulus spills abroad. The International Monetary Fund last week revised up its global growth forecast for 2018 in response to the U.S. tax overhaul. The plan features broad corporate tax cuts and allowances for companies to immediately expense capital spending. The incentive to raise capital spending could reinforce a business investment recovery that is underway. Stronger business investment should lift U.S. potential growth and lead to more U.S. imports. This is how the stimulus-growth boost could be shared beyond U.S. borders, and give the expansion more breadth and a longer lifespan. Deeply intertwined global trade and corporate supply chains mean demand is better redistributed around the world.

What are the risks?

We particularly worry about U.S. trade actions—such as a U.S. trade war with China or a unilateral pull-out from the North American Free Trade Agreement—reversing decades of deeper global economic and financial integration. It is not our base case, but we recognize market sentiment can shift quickly and investors might fear that rising U.S. protectionism causes a downturn in global trade. We believe the global expansion can push on, assuming U.S. overheating pressures are contained with global help. This creates a solid foundation for investors to put money to work in risk assets, as we highlight in our 2018 Global Investment Outlook. Read more market insights in my Weekly Commentary.

Richard Turnill is BlackRock’s global chief investment strategist. He is a regular contributor to The Blog.

In the latest episode of The Bid podcast, Richard Turnill discusses the current golden age of prolonged and stable economic growth and answers the tough question: Can it persist?

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