Bond Market Observations: The Music of the Moment

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Oct 2017 BMO

Standish

Standish - Investment Committee

NSYNC is not just a boy-band of the 2000s, but it is also the mood right now among an entirely different demographic, economic policymakers around the world. At the just-completed annual meetings of the International Monetary Fund (IMF) and World Bank, the received wisdom of the (older and higher-level) crowd was that the world economy is enjoying a synchronous expansion. Indeed, in the IMF’s World Economic Outlook, released just before that meeting, economic distress was in short supply. Chart 1 gives the share of the 193 economies covered, by year, that are forecasted to be in recession and that are growing but decelerating, growing about at the their prior pace, and accelerating, The gold hues of contraction and slowing take up the least real estate this year and next in the four-decade sample.

That said, the pace of economic expansion is slow, with global activity increasing at about a 3-3/4 percent pace. This is a bit above longer-term trend, assessed at 1-3/4 percent for advanced economies and 3-3/4 percent for emerging market economies.1 The economic pie is growing more slowly because productivity growth has stalled everywhere and the aging populations of advanced economies are growing slowly and participating less in the organized work force.

With growth above that of its longer-term trend, the dysfunctional outcome of effective deflation is viewed as rare. More economies settle into a zone of price stability, or inflation between 1 and 3 percent. Higher inflation and the other dysfunctional outcome, hyperinflation, across the world should be much less frequent.

Inflation is expected to run about 1-3/4 percent this year and next among advanced economies in the IMF forecast. Our own forecast for the US is above that, with inflation ticking higher to overshoot the Federal Reserve’s goal (in CPI terms) of 2 percent next year. As a result, we are upbeat on breakeven inflation. True, that has been the case for some time. In retrospect, the drag on domestic inflation from earlier dollar appreciation lasted longer and was more sizable than expected. A strong dollar, however, is mostly in the rearview mirror, so external impetus to domestic prices is building, and we stick to the belief that breakevens are attractive.

1These are the five-year-ahead forecasts of real GDP growth by IMF staff, which should have no cyclical element.

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