The world economy generally performed well during the first half of 2018. A handful of emerging markets struggled, but their problems were at least partially of their own making. The major markets, in aggregate, met expectations.

But as we contemplate the outlook, satisfaction with the first six months of the year is tempered by apprehension over the spread of trade conflicts. No region has been spared, and some are especially threatened. No one wins in a trade war, but those more reliant on exports will be more highly inconvenienced.

We are still expecting the ultimate impact of restrictive trade measures to be modest, and that cooler heads will eventually craft productive resolutions to Brexit, NAFTA and the stress between the United States and China. That outcome is embedded into the base case described below. But the risk of further trade tensions creates downside risk for the second half.

United States: Fiscal Tailwinds Remain Strong

The U.S. is currently outperforming. Early estimates of gross domestic product (GDP) growth for the second quarter are very strong: the first half is likely to show annualized real growth of 3% or better.

The persistent effects of the Tax Cuts and Jobs Act position the U.S. for strong growth in the second half of the year. However, we expect the expansion to downshift to a more sustainable rate in 2019 as temporary incentives from tax reform expire and the costs of trade actions become more apparent. Though growth will slow, we do not expect a
downturn. Unemployment is likely to hold at low levels through 2019.

Several factors are likely to bring about a long-delayed round of inflation. Little slack remains in the labor market, and wage pressures will rise. Energy prices have already risen; though domestic oil production is also increasing, the loss of oil exports from Iran and Venezuela will only keep the heat on this market. Lastly, tariffs will inflate the costs of intermediate and finished goods.

The Federal Open Market Committee has set clear expectations of continued increases to the overnight federal funds rate as long as economic growth and inflation continue. We anticipate two more rate increases this year and three more to follow in 2019.