2018-2019 Forecast: External Calm

Genevieve Signoret


External calm

We envision three scenarios for the global economy and world markets in 2018–2019. Our central scenario, which we call External Calm and to which we assign a 75% subjective probability, assumes that, outside of Mexico, in politics and geopolitics, tensions neither rise nor fall, China decelerates, and trade wars scarcely slow down trade. Last year’s U.S. fiscal stimulus spurs new supply but does nothing for demand, and, if Congress passes an infrastructure plan at all, the plan fails to produce much demand. Fortunately, the Fed reads these signs and slows down its actual and projected tightening path. Optimism still prevails in credit and stock markets.

Under these assumptions, we see the global economy continuing to grow at a decent clip, while inflation stays under control. For end 2018, we see the upper limit of the Fed’s target range for the federal funds rate reaching 2.25%, the yield on a 10-year U.S. Treasury bond at 3.12% and the dollar versus the euro and yen at €1.00 =$1.30 and $1.00=¥120. Over the next 12 months, the Fed rate climbs to 2.75%, the 10-year Treasury yield to 3.24%, and the dollar against the euro and yen to €1.00 =$1.34 y $1.00=¥120.

Domestic volatility

For Mexico, we assume that, while Andrés Manuel López Obrador’s rise to the presidency does not produce panic, it does induce both caution in fixed investment and instability in peso markets.

Under these assumptions, we see the peso ending 2018 at $1.00=MXN19.00 and 2019 at $1.00=MXN18.50. Banxico, upon observing peso weakening, resumes its tightening path: in 2018 it hikes rates to 8.25% and leaves them there throughout 2019. Growth decelerates in 2018 (real GDP slows to 2.0%) and barely recovers (to 2.3%) in 2019, but inflation continues its descent (to 4.1% by December 2018 and stays in 4.1% one year later).

Risk scenarios

We also imagine a more pessimistic scenario, called Recession in 2019. We give it a 15% subjective probability. Geopolitical tensions rise, the Fed tightens too fast, trade wars expand, markets turn pessimistic, and López Obrador’s election produces panic. The global economy goes into recession next year. Against the dollar, the yen strengthens, while the euro weakens, and the peso falls at times to $1.00=MXN25.00. The 10-year U.S. Treasury bond appreciates to an end-2019 yield of 2.10%.

On the other hand, we also envision an optimistic scenario called U.S. mania (probability=10%), in which geopolitical tensions relax, López Obrador loses the election in Mexico, U.S. demand enjoys stimulus, trade wars dissipate, the Fed allows some inflation, and credit and stock markets enter a manic phase. The yen and euro depreciate against the dollar and the peso gains. The yield on a 10-year bond by December 2019 has risen to 4.00%.

Annual forecast under central scenario

Read the full report, including detailed scenario assumptions and a complete set quarterly and annual trajectories.

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