In this Issue:

US Economy’s Fundamentals Justify Optimism, but Inflation Still Subdued

The current widespread optimism about the US economy is largely justified, in our view, by its strong fundamentals, particularly the positive backdrop for consumers. Despite the economy’s robust growth, we do not view the recent rise in US Treasury yields as heralding the start of a major selloff across bond markets. Inflation shows little sign of breaking out of its pattern of sluggish and limited gains, as long-term constraints such as demographics and technology continue to exert downward pressure on prices, though the recent rise in energy prices could act as an offset if sustained. The Trump administration’s trade policies and the upcoming midterm congressional elections create further uncertainty among investors about the outlook for 2019, which we believe could serve to cap any rise in yields over the coming months.

Global Economy Maintains Solid Momentum as Trade Concerns Subside

The impact of recent developments in emerging markets remains marginal, in our view, with little effect so far on the outlook for the G7 economies. In the absence of a major crisis—for example, a sovereign default—we believe the global economy’s solid momentum should be maintained, underpinned by the strength of US demand. Consequently, we see little reason for the leading central banks to deviate significantly from the monetary policy trajectories they have currently laid out. Concerns among investors about trade tensions appear to have subsided somewhat for the time being, though the ongoing uncertainty around US policy means this issue could swiftly create further market volatility.

Italy’s Budget Talks with EU Could Lead to Looser Fiscal Policy Elsewhere in Eurozone

As negotiations on the United Kingdom’s (UK’s) withdrawal from the European Union (EU) drag on, Italian politics are also likely to present a challenge for policymakers in Brussels. The EU faces a tough task in persuading Italy’s populist government to maintain fiscal discipline without increasing support among the country’s voters for eurosceptic policies. However, a compromise allowing a limited expansion of the Italian budget seems the most likely outcome, in our view. Such a deal could also encourage other eurozone countries to modestly loosen their fiscal stance. Any resulting growth stimulus may prove a timely counterbalance to the expected phasing out of the European Central Bank’s (ECB’s) bond purchases at the end of 2018.

US Economy’s Fundamentals Justify Optimism, but Inflation Still Subdued

The current widespread optimism about the US economy is largely justified, in our view, by its strong fundamentals, particularly the positive backdrop for consumers. If the fiscal stimulus that has likely contributed the most to the present elevated rate of expansion has also sparked some more secular growth-enhancing trends—for example, productivity gains through higher capital expenditure—then it could provide a further leg to the already prolonged economic cycle. However, we believe it is still too early to determine whether such developments are occurring.