Global scenarios service: Q1 2017Global scenarios service Q1 2017 3 Scenario 2 – Le Pen victory...

Global scenarios service Q1 2017

Global scenarios service: Q1 2017

Le Pen threatens to rewrite the global risk outlook


Contents

Executive Summary ................................................................................................... 1

1 Baseline scenario ................................................................................................ 9

2 Le Pen victory sparks Eurozone crisis ............................................................ 11

3 Bond market sell-off .......................................................................................... 20

4 Tighter policies in China ................................................................................... 29

5 Trump presidency weighs on global growth ................................................... 37

6 US growth surges amid Trump fiscal stimulus ............................................... 46


Executive Summary

Political uncertainty continues to dominate the global economic landscape. Over the past three

months, concerns have heightened over the impact of major shifts in US policy on the global

economy, even as our baseline forecast has edged up with the prospect of fiscal stimulus in the US.

But, as highlighted in the latest Oxford Economics Global Risk Survey, a key emerging risk lies

outside of the US, amid increased fears over rising populism in the EU—and the consequences of a

potential Le Pen victory in the upcoming French presidential elections.

We explore these and other key economic risks in this report:

Le Pen victory sparks Eurozone crisis (GSS weight=5%): A Marine Le Pen victory in France

raises doubts about the future of the Eurozone, once more plunging Europe into crisis.

Bond market sell-off (GSS weight=10%): The bond market rout continues, choking off US recovery

and spilling over globally.

Tighter policies in China (GSS weight=10%): The Chinese authorities scale back growth targets

and rein in the expansion of credit to a more sustainable trajectory.

Trump presidency weighs on global growth (GSS weight=10%): Fiscal stimulus hopes are

dashed as President Trump refuses to negotiate with Congress and adopts a highly protectionist and

isolationist stance.

US growth surges amid Trump fiscal stimulus (GSS weight=25%): Trump negotiates a relaxation

of fiscal orthodoxy in exchange for a less protectionist trade stance.

Chart 1: Scenario-based distribution of global growth in 2018

Note: Each bar represents a different 0.1 percentage point range, with the estimated probability of growth falling in that range shown on the y-axis. Dashed lines show the 2018 world GDP growth outcome under the baseline and the different scenarios. Methodological assumptions, including the distribution around each scenario and the interaction of scenarios, are set out here.

https://www.oxfordeconomics.com/my-oxford/publications/357756

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Scenario 1 – Baseline

In our baseline forecast, global growth strengthens over the near term. We assign a Global Scenarios

Service (GSS) weight of 40% to this scenario.

Oxford Economics’ central forecast envisages world growth of 2.6% in 2017 and 2.9% in 2018, 0.1-0.2pp

higher than expected three months ago and above the 2.2% pace experienced in 2016. The US drives the

upward revision: with a Trump fiscal stimulus package now in prospect, we expect 2.3% and 2.5% growth in

2017 and 2018 (previously 2.0% and 1.9%). The growth outlook has also improved a little in the Eurozone

and, following recent yen depreciation, in Japan.

Higher inflation is also in prospect. At the global level, inflation is expected to rise to 3.3% in 2017, compared

with 2.7% in 2016. In part, this reflects the direct impact of higher commodity prices, with oil prices this year

expected to be $2 higher at $52 per barrel than anticipated three months ago. But we have also revised up

our forecasts for core inflation in the US and Germany, at the same time as the weaker yen adds to the

inflationary impetus in Japan.

While monetary policy remains supportive, a faster pace of policy tightening is now envisaged against the

more reflationary backdrop. In the US, the Federal funds rate is expected to reach 1.7% by the end of 2018,

around 0.3pp higher than three months ago. Consistent with more rate rises and higher inflation, our

baseline forecast also sees US government bond yields rise more rapidly, to 3.2% by the end of 2018, 0.6pp

higher than at the time of the previous report; yields are also modestly higher in other advanced economies,

including the Eurozone and Japan. In foreign exchange markets, the post-election dollar strength—and euro

and in particular yen weakness—is also sustained over the forecast period.

Chart 2: Oxford Economics Global Risk Survey—downside risks


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Scenario 2 – Le Pen victory sparks Eurozone crisis

In this scenario, we explore rising populism in the EU—a key risk highlighted in the latest Global Risk Survey

(see chart 2 above). We assume that Marine Le Pen, the right-wing populist candidate, is victorious in May’s

presidential elections in France and the Front National wins a majority in France’s parliamentary elections

the following month. With the French president given a mandate to renegotiate the terms of France’s

membership of the European Union and the Eurozone, Europe is plunged once more into crisis.

In recent months, Le Pen has gained in the polls, as the range of presidential candidates has narrowed and

with Republican Francois Fillon facing formal investigation. A Le Pen victory still remains unlikely given

France’s two-round presidential election system. And, even in the event of a Le Pen victory, the economic

impact would be most likely be relatively benign, especially if the Front National fails to secure a

parliamentary majority. But, as this scenario explores, there is the risk of a more disruptive turn of events.

In the scenario, victories for Le Pen and the Front National spark fears of Eurozone breakup, prompting a

sharp sell-off in bond markets in France, but even more so in peripheral Eurozone economies. Equity

markets experience a sharp adverse reaction across the euro area, and the value of the euro falls

significantly. Credit conditions and investor confidence deteriorate, spilling over to the real economy.

Confidence is further shaken as Le Pen reiterates her campaign rhetoric on France’s relationship with the

EU. The new president demands greater barriers to trade and immigration, threatening to pull the country out

of the EU and Eurozone should her demands not be met. Le Pen’s brinkmanship weighs further on

investment in Europe, as uncertainty on the outcome of negotiations with the EU increases. The ECB

intervenes as a result, extending quantitative easing and commencing equity purchases.

Ultimately, Le Pen backs down, unwilling to take France out of the EU or Eurozone given the associated

economic and political cost. Economic conditions begin to normalise from early 2019. By then, the level of

GDP is already 1.2% below baseline in the Eurozone and 1.3% lower in France itself. But the global impact

is more muted, with world GDP down 0.6% overall.

We assign a 5% GSS weight to this scenario.

Scenario 3 – Bond market sell-off

The surge in bond yields and sustained dollar strength since the US presidential election have raised

concerns that tightening financial conditions could choke the US recovery before the expected fiscal stimulus

comes to pass. Our previous analysis suggests that these fears are overdone for now, but that risks are

likely to materialise if the bond rout continues. This scenario explores these risks.

In the scenario, inflationary pressures prompt the Fed to raise rates more quickly, hiking four times during

2017. With investors reassessing the future pace of tightening, and term premia edging up from historically

low levels, US Treasury yields surge higher. The shock spills over to global markets: bond yields spike up,

the dollar makes further gains and world equity prices fall.

The economic impact varies across countries. In the US, credit conditions tighten as short- and long-term

rates rise, weighing on domestic demand. But the shock is buffered as the Fed slows its pace of tightening

from 2018 and fiscal stimulus comes on stream. Other advanced economies – while facing higher yields and

a weaker trade outlook – are also able to cushion the blow by keeping policy rates lower for longer.

But many emerging market economies are forced to raise rates in an attempt to staunch capital outflows and

defend their currencies. Worst hit are those, such as Malaysia and Venezuela, that are vulnerable to a

stronger dollar and weaker commodity prices.

We assign a GSS weight of 10% to this scenario.




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Scenario 4 – Tighter policies in China

While China comfortably met the target of at least 6.5% GDP growth in 2016, a big question for 2017 and

beyond is whether the authorities will continue to aim for overly ambitious GDP growth targets or start to rein

in credit to put growth on a more sustainable footing. In this scenario, we consider the latter possibility.

Under this scenario, China’s policymakers recognise the unsustainability of the current debt trajectory; they

decide to lower their overly ambitious growth targets and they rein in the expansion of credit, supported by

structural reforms to bolster the role of equity financing and the efficiency of the financial sector. Credit

growth is gradually reduced and the ratio of credit to GDP peaks in late 2021. Investment spending is hit in

particular. But, in the absence of abrupt property, equity or FX corrections, spill-overs to the rest of the world

are contained compared with a more adverse scenario.

The overall result is a delay to the anticipated pickup in the pace of global economic expansion. World GDP

growth remains subdued at 2.4% in 2017 and 2.2% in 2018, compared with the baseline rise to 2.6% and

2.9% respectively. But there are marked differences in the impact on GDP across countries. Those that

suffer most are China itself, commodity producers such as Russia and Venezuela, and China’s Asian

neighbours such as Hong Kong and Singapore.

In financial markets, Asian and commodity-exporters’ currencies depreciate, owing to the fall in oil and other

commodity prices and slower growth in the Chinese economy. Advanced-economy government bond yields

weaken as policy rates remain low for longer. And global equity prices weaken, remaining depressed

throughout the forecast period.


Scenario 5 – Trump presidency weighs on global growth

In our adverse Trump scenario, we assume that, the new president adopts a highly protectionist and

isolationist stance, fails to implement a significant fiscal stimulus package and proceeds with immigration

curbs and deportations that result in substantial labour force declines. Against a backdrop of heightened

uncertainty, the US and global economies are badly shaken.

On trade, Trump proceeds with his proposed 35% and 45% trade tariffs on Mexico and China in H2 2017

and maintains them throughout his presidency; further tariffs are also imposed on South Korea and Taiwan.

These trading partners retaliate by matching the tariffs imposed by the US.

Trump’s refusal to negotiate on his extreme trade proposals means that the Republicans maintain a deficit-

neutral stance on the budget. The resulting fiscal package involves $500 billion of tax cuts over the next ten

years—a less substantial, more regressive policy change than in the baseline and matched by offsetting

revenues and spending cuts. The $200 billion infrastructure stimulus assumed in our baseline forecast also

fails to materialise.

The economic and market implications are profound. By late-2019, the US economy has entered recession;

by 2021 the economy is 6% smaller than in the baseline forecast. As the impact of Trump’s policies spills

over, the global recovery is undermined, with world growth only returning to baseline at the very end of the

five-year forecast. Commodity and asset market impacts are similarly marked, with oil prices weaker and

substantial movements in both policy rates and yields.





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Scenario 6 – US growth surges amid Trump fiscal stimulus

While our first Trump scenario examines an adverse outcome for the US economy, a possibility highlighted

by the latest Oxford Economics Global Risk Survey (see chart 3 below) is that the result of congressional

negotiations is far more stimulatory. In particular, a greater relaxation of fiscal orthodoxy might be achieved

in exchange for a less protectionist stance than the new president campaigned on, as we explore in our

upside Trump scenario.

In this scenario, the result of congressional negotiations is significantly more expansionary than assumed in

the baseline. The fiscal package is larger, with $2 trillion worth of personal income and corporate tax cuts

and a $250 billion public infrastructure investment plan. In exchange, Trump refrains from imposing trade

restrictions.

As a result, the US economy grows more quickly than in the baseline. It benefits not only from the initial

impact of lower taxes and increased infrastructure spending, but also increased confidence in Trump and his

team’s ability to govern. In 2017, growth edges up to 2.5% (2.3% in the baseline); in 2018, when the boost

from fiscal stimulus and private sector confidence peaks, growth reaches 3.6% (compared with 2.5%).

The global economy grows more quickly as stronger US growth spills over, fears over increased

protectionism dissipate and confidence improves. World growth reaches 2.7% in 2017 and 3.3% in 2018,

0.1-0.4pp above baseline. But the impact varies widely across countries, reflecting policy and market

developments. Economies around the world benefit from renewed confidence, stronger global trade and

more buoyant equity markets. But, as the Fed brings forward its tightening cycle (with the ECB and Bank of

England following suit), a stronger dollar and higher US interest rates reduce the attractiveness of emerging

market assets. As capital flows from emerging markets to the US amid investor concerns over the impact on

emerging market balance sheets and reduced incentives to 'hunt for yield', credit conditions tighten in more

vulnerable emerging market economies and the boost to activity is at least partially tempered.


Chart 3: Oxford Economics Global Risk Survey—upside risks





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Figure A: Summary of main scenarios

The results from these scenarios are available in other formats. Excel and chart pack data, including for key

asset price variables, can be downloaded here. Full scenario data results are available on the GSS databank

– for an expanded selection of 80 economies, made possible through the recent expansion of the Oxford

Global Economic Model.

http://www.oxfordeconomics.com/my-oxford/global-scenarios-service

http://services.oxfordeconomics.com/data/


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2015 2016 2017 2018 2019 2020 2021

Oxford Baseline Forecast (GSS weight=40%)

US 2.6 1.6 2.3 2.5 1.8 1.6 1.6

Eurozone 1.9 1.7 1.5 1.5 1.4 1.3 1.3

China 6.9 6.7 6.3 5.9 5.7 5.6 5.4

World 2.7 2.3 2.6 2.9 2.8 2.7 2.7

Le Pen victory sparks Eurozone crisis (GSS weight=5%)

US 2.6 1.6 2.1 2.2 2.0 1.6 1.7

Eurozone 1.9 1.7 1.3 0.5 1.4 1.6 1.5

China 6.9 6.7 6.2 5.5 5.6 5.6 5.7

World 2.7 2.3 2.5 2.5 2.8 2.7 2.9

Bond market sell-off (GSS weight=10%)

US 2.6 1.6 2.0 1.8 1.7 1.7 1.8

Eurozone 1.9 1.7 1.4 0.7 1.0 1.3 1.5

China 6.9 6.7 6.0 4.7 5.7 5.9 5.5

World 2.7 2.3 2.4 2.2 2.5 2.7 2.9

Tighter policies in China (GSS weight=10%)

US 2.6 1.6 2.2 2.0 1.4 1.8 1.7

Eurozone 1.9 1.7 1.3 0.8 1.0 1.4 1.4

China 6.9 6.7 5.7 4.6 4.8 5.0 4.8

World 2.7 2.3 2.4 2.2 2.2 2.6 2.6

Trump presidency weighs on global growth (GSS weight=10%)

US 2.6 1.6 1.6 1.0 0.0 0.0 0.8

Eurozone 1.9 1.7 1.2 0.9 1.1 1.3 1.4

China 6.9 6.7 5.8 4.0 4.6 5.0 5.7

World 2.7 2.3 2.2 1.9 2.0 2.1 2.6

US growth surges amid fiscal stimulus (GSS weight=25%)

US 2.6 1.6 2.5 3.6 2.2 1.8 1.8

Eurozone 1.9 1.7 1.7 1.8 1.5 1.2 1.1

China 6.9 6.7 6.5 6.4 6.5 6.0 5.5

World 2.7 2.3 2.7 3.4 3.0 2.7 2.7

Alternative GDP growth forecasts*

Note: World GDP growth at 2010 prices and market exchange rates. We report in brackets the weights attached to the baseline and different scenarios. GSS weights are constrained to sum to 100%. See our previous research for more information about scenario probabilities and how they can be used to construct a scenario-based distribution (see also Chart 1 on page 1).





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Equities Bond yields Short rates Currencies

(% change) (% point difference) (% point difference) (% change)

Oxford Baseline Forecast

(GSS weight = 40%)

China 7.9 0.5 -0.1 0.3

Eurozone 3.6 0.7 0.0 -3.1

UK 5.1 0.6 0.0 -2.5

Japan 3.5 0.0 0.0 -10.0

US 5.8 0.8 1.4 0.8

Le Pen victory sparks Eurozone crisis

(GSS weight = 5%)

China 4.9 -0.2 -0.5 0.7

Eurozone -18.9 1.0 0.1 -8.1

UK -1.7 0.2 -0.2 -5.7

Japan -2.7 -0.4 0.0 -8.9

US 3.9 0.0 0.7 2.4

Bond market sell-off

(GSS weights = 10%)

China 4.6 0.8 -1.5 -1.4

Eurozone -0.6 0.9 0.1 -3.9

UK 0.5 0.9 -0.1 -3.6

Japan 3.0 0.0 -0.3 -11.5

US 1.0 1.1 1.8 3.1

Tighter policies in China

(GSS weights = 10%)

China -3.3 -0.3 -1.7 -0.9

Eurozone -1.4 0.6 0.0 -2.2

UK 0.6 0.6 0.0 -1.7

Japan -2.2 -0.2 0.0 -9.0

US -1.2 0.4 0.7 1.0

Trump Presidency weighs on global

growth (GSS weight = 10%)

China -2.2 0.1 -0.4 -1.1

Eurozone -3.4 0.3 0.0 1.1

UK -0.8 0.2 -0.2 -1.7

Japan -3.6 -0.3 -0.1 -6.4

US -7.8 -0.7 -0.4 2.0

US growth surges amid Trump fiscal

stimulus (GSS weight = 25%)

China 14.1 0.7 0.3 -2.6

Eurozone 9.1 0.9 0.1 -3.9

UK 11.8 0.9 0.2 -3.1

Japan 8.3 0.0 0.0 -10.9

US 15.3 1.3 1.9 2.4

Asset performance under each scenario*

Note: Performance between Q1 2017 and Q1 2019. Equity indices used for each country are as follows: China - Shanghai Stock Price Index; Eurozone - Euro Stoxx 50; UK - FTSE All Share; Japan - Topix Composite; US -Wilshire 5000 Price Index. Bond yields are all based on 10 year government bonds. All currencies are based against the dollar except for the US which uses the Broad-Based index, and are calculated so that a positive number shows an appreciation and a negative number shows a depreciation. We report in brackets the weights attached to the baseline and different scenarios. GSS weights are constrained to sum to 100%. See our previous research for more information about scenario probabilities and how they can be used to construct a scenario-based distribution (see also Chart 1 on page 1).




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1 Baseline scenario

The Oxford Economics central forecast for global growth has edged down a little further since our previous

report. This section summarises the key features of the forecast (see also February’s World Economic

Prospects and Global macro chartbook); risks around this baseline are examined in subsequent sections.

Key features

The key features of the baseline scenario may be summarised as follows:

Global growth strengthens over the near term. With global indicators continuing to point to a pickup in

activity, Oxford Economics’ central forecast envisages world growth of 2.6% in 2017 and 2.9% in 2018,

0.1-0.2pp higher than envisaged three months ago and above the 2.2% pace experienced in 2016.

The US drives the upward revision to global growth: with a Trump fiscal stimulus package in

prospect, we expect 2.3% and 2.5% growth in the US in 2017 and 2018 (previously 2.0% and 1.9%).

In Europe, where no populist parties are assumed to enter government, further moderate growth

is expected. Following growth of 1.7% in 2016, the Eurozone economy is assumed to grow by 1.5% in

2017 and 2018 in the scenario, 0.1pp higher than envisaged three months ago. In the UK, GDP growth

slows to 1.6% in 2017 and 1.3% in 2018, with household spending power increasingly under pressure

from higher inflation.

The growth outlook for Japan has also improved. We now envisage growth of 1.2% in 2017 and 1.3%

in 2018, as a weaker currency and a gradually improving outlook for global trade facilitate a stronger

export performance over the next two years. Government investment is also set to grow strongly this year

and next, with around ¥6 trillion of the supplementary budget to finance infrastructure.

While China recorded growth of 6.7% in 2016, continued fast growth last year was achieved at the cost of

a further rise in leverage. Chinese growth is assumed to ease, but only gradually over the forecast

period, to 6.3% in 2017 and 5.9% in 2018.

Globally, higher inflation is in prospect. World inflation is expected to rise to 3.3% in 2017, compared

with 2.7% in 2016.

The more inflationary outlook partly reflects the direct impact of higher commodity prices, with oil

prices this year expected to be $2 higher at $52 per barrel than anticipated three months ago. But we

have also revised up our forecasts for core inflation in the US and Germany, at the same time as the

weaker yen increases inflationary pressure in Japan.

While US monetary policy remains supportive, a faster pace of Fed policy tightening is now

envisaged against the more reflationary backdrop. In our February forecast update, we raised the

expected level of the Federal funds rate by end-2018 to 1.7%, around 0.3pp higher than three months

ago, and we have since raised our US policy rate forecast further. Elsewhere, the Bank of Japan

maintains its ‘around 0%’ 10-year bond yield target.

US bond yields are likely to continue to rise. Consistent with further rate rises and higher inflation, our

baseline forecast sees US government bond yields edge up to 3.2% by the end of 2018, 0.6pp higher

than at the time of the previous report; yields also rise in other advanced economies, including in the

Eurozone and the UK.

In foreign exchange markets, the post-election dollar strength is also sustained. The euro falls to

parity with the US dollar by end-2017 and the yen-dollar exchange rate reaches 124 as US monetary

policy increasingly diverges from policy in the Eurozone and Japan.






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2014 2015 2016 2017 2018 2019 2020 2021

Real GDP

North America

United States 2.4 2.6 1.6 2.3 2.5 1.8 1.6 1.6

Canada 2.6 0.9 1.3 1.8 1.8 1.9 1.9 1.9

Europe

Eurozone 1.2 1.9 1.7 1.5 1.5 1.4 1.3 1.3

Germany 1.6 1.5 1.8 1.5 1.4 1.2 1.0 0.9

France 0.7 1.2 1.1 1.4 1.6 1.5 1.4 1.3

Italy 0.2 0.6 1.0 0.8 1.0 1.0 1.0 1.0

UK 3.1 2.2 2.0 1.6 1.3 1.6 2.1 2.3

EU27 1.6 2.1 1.9 1.6 1.6 1.5 1.5 1.5

Asia

Japan 0.2 1.3 1.0 1.2 1.3 0.8 -0.3 0.6

China 7.3 6.9 6.7 6.3 5.9 5.7 5.6 5.4

India 7.0 7.2 7.1 6.7 7.2 6.9 6.6 6.4

World 2.8 2.7 2.3 2.6 2.9 2.8 2.7 2.7

World 2005 PPPs 3.4 3.2 3.0 3.3 3.6 3.5 3.4 3.4

World trade 2.9 1.6 1.7 3.3 3.3 3.7 3.8 3.8

Inflation (CPI)

North America

United States 1.6 0.1 1.3 2.5 2.2 2.0 1.9 2.0

Canada 1.9 1.1 1.5 2.1 1.9 1.9 2.0 2.0

Europe

Eurozone 0.4 0.0 0.2 1.7 1.5 1.8 1.9 1.9

Germany 0.9 0.2 0.5 2.1 1.9 2.2 2.3 2.1

France 0.5 0.0 0.2 1.3 1.3 1.5 1.8 1.9

Italy 0.3 0.0 -0.1 1.3 1.3 1.8 1.9 1.8

UK 1.5 0.1 0.6 2.5 2.1 1.8 1.9 1.9

EU27 0.5 0.0 0.3 1.8 1.7 1.9 2.0 2.0

Asia

Japan 2.8 0.8 -0.1 0.6 0.8 1.2 1.8 1.1

China 2.0 1.4 2.0 2.4 2.5 2.8 2.8 2.8

India 6.6 4.9 4.9 4.7 5.4 5.2 5.0 4.7

World 3.2 2.8 2.7 3.3 3.1 3.1 3.1 3.0

Exchange Rates

US$ Effective 78.4 90.9 91.6 96.0 97.8 96.7 94.6 92.3

$/€ 1.33 1.11 1.11 1.04 1.01 1.04 1.07 1.10

¥/$ 105.9 121.0 108.8 118.7 125.4 127.0 126.7 125.0

Commodity Prices

Brent oil ($/bl) 99.0 52.4 43.5 52.0 52.0 58.9 67.5 75.2

Oxford Economics' Baseline Forecasts


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2 Le Pen victory sparks Eurozone crisis

In this scenario, we explore rising populism in the EU—a key risk highlighted in the latest Global

Risk Survey. We assume that Marine Le Pen, the right-wing populist candidate, is victorious in May’s

presidential elections in France and the Front National wins a majority in France’s parliamentary

elections the following month. With the French president given a mandate to renegotiate the terms of

France’s membership of the European Union and the Eurozone, Europe is plunged once more into

crisis.

In recent months, Le Pen has gained in the polls, as the range of presidential candidates has narrowed and

with Republican Francois Fillon facing formal investigation. A Le Pen victory still remains unlikely given

France’s two-round presidential election system. And, even in the event of a Le Pen victory, the economic

impact would be most likely be relatively benign, especially if the Front National fails to secure a

parliamentary majority. But, as this scenario explores, there is the risk of a more disruptive turn of events.

In the scenario, victories for Le Pen and the Front National spark fears of Eurozone breakup, prompting a

sharp sell-off in bond markets in France, but even more so in peripheral Eurozone economies. Equity

markets experience a sharp adverse reaction across the euro area, and the value of the euro falls

significantly. Credit conditions and investor confidence deteriorate, spilling over to the real economy.

Confidence is further shaken as Le Pen reiterates her campaign rhetoric on France’s relationship with the

EU. The new president demands greater barriers to trade and immigration, threatening to pull the country out

of the EU and Eurozone should her demands not be met. Le Pen’s brinkmanship weighs further on

investment in Europe, as uncertainty on the outcome of negotiations with the EU increases. The ECB

intervenes as a result, extending quantitative easing and commencing equity purchases.

Ultimately, Le Pen backs down, unwilling to take France out of the EU or Eurozone given the associated

economic and political cost. Economic conditions begin to normalise from early 2019. By then, the level of

GDP is already 1.2% below baseline in the Eurozone and 1.3% lower in France itself. But the global impact

is more muted, with world GDP down 0.6% overall.

We assign a 5% GSS weight to this scenario, which was quantified using the Oxford Global Economic

Model1.

Assumptions

The main assumptions for the scenario are as follows:

Marine Le Pen is elected in the French presidential election in May, and her party wins a majority

in the parliamentary elections in June. This gives her a strong mandate from the French people to

renegotiate the terms of France’s membership of the European Union and Eurozone.

A sharp selloff in French and peripheral bond markets leads to a spike in sovereign yields, with

the spread between French and German yields rising to around 225 basis points. Spreads rise by even

more in Italy and Spain and by roughly 650 basis points in Portugal. This causes a deterioration in credit

conditions and bank lending.

1 The Oxford Global Economic Model is a fully integrated global economic model used for forecasting and ‘what if’

analysis. The model now covers 80 economies in detail including the US, Japan, most EU economies, China, India and other leading emerging markets. It also gives headline indicators for another 30 economies. The model provides a rigorous and consistent structure for analysis and forecasting, and allows the implications of alternative global scenarios and policy developments to be readily analysed and quantified, taking into account all of the linkages between economies – through trade volumes and prices, oil and commodity prices, financial markets, capital flows and more.






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Eurozone equity prices fall by 28% peak to trough in 2017, compared with a peak-to-trough fall of

22% during the 2011/12 crisis.

The euro depreciates sharply, by around 10%, with the exchange rate falling to a low of 0.96 against

the dollar in 2017 Q3, before rallying slightly. This compares with a peak depreciation of 23% and a low

of 1.25 during the 2011/12 crisis. The euro begins to recover in value from Q1 2019, but remains 2.3%

weaker than baseline by 2021 as monetary policy diverges further with the US.

Le Pen drags Europe into lengthy negotiations on key pillars of the EU, such as free movement of

people and goods, threatening to put France’s membership to a referendum.

The fear of a costly French exit from the Eurozone results in a deterioration in Eurozone

confidence—equivalent to around two-thirds of the size of shock experienced during the 2011/12 crisis

and calibrated to be consistent with our expectation that, particularly in France, corporate and investor

sentiment would be more adversely affected than consumer confidence. As a result, firms delay

investment; inward FDI into the region also declines as external confidence in the region falters.

The UK is not immune, with activity knocked by a loss of confidence, weakness in its largest trading

partner and falls in equity prices. In addition, while the UK’s ultimate relationship with the EU is

unaffected by the crisis, concerns rise in the short term over the impact of Brexit against a weaker

economic backdrop and the potential for negotiations to prove more protracted than anticipated.

In France itself, Le Pen implements looser fiscal policy. Based on her manifesto pledges, we assume

an increase in French government investment equal to 1% of GDP, phased in over the five years of the

scenario, and the effective corporate tax rate is lowered 3pp from Q1 2018.

Le Pen also cuts annual non-EU migration to a level 130,000 below baseline. Combined with a

lowering of the retirement age to 60 as of Q1 2018, this leaves the labour supply 0.6% lower relative to

baseline by the end of the scenario, decreasing France’s potential output.

The ECB actively intervenes at two key stages of the scenario. Following the initial spike in yields,

the ECB confirms its readiness to intervene with additional policy support, tempering the spike in yields.

In Q4 2017, it then announces an extension of the existing of €60bn per month programme of asset

purchases beyond end-2017; given the shortage of available government bonds, equities are included

via an ETF purchase programme.

In Q1 2019, Le Pen backs down and household, business and market sentiment begin to recover.


13

Table 2.1: Transmission of ‘Le Pen victory sparks Eurozone crisis’ scenario

Real economy results

The real economy results of this scenario may be summarised as follows:

The countries that suffer the largest hit to GDP are:

Peripheral Eurozone economies, which see the largest increase in sovereign yields and the

greatest tightening of credit conditions as fears of Eurozone breakup increase.

France, which experiences a substantial shock to bond prices, sizeable equity price declines and a

hit to potential output as it reduces immigration, mitigated in the short term by looser fiscal policy.

The Eurozone in general, with Germany and other less directly exposed Eurozone member states

still adversely affected by weaker confidence, tighter credit conditions and slowing EU trade.

Less affected are economies with more limited trade and financial linkages to Europe and limited

reliance on global commodity markets.

The Eurozone suffers a 1.2% loss in the level of GDP by 2018, with growth slowing to 1.3% in 2017

and 0.5% in 2018. Despite subsequent recovery, the level of GDP is still 0.8% below baseline in 2021.

The US is more moderately affected. The impact of trade and financial spill overs, including a

strengthening dollar amid safe haven capital inflows, is partially offset by a slower pace of Fed tightening

and lower long term yields. US GDP is 0.5% below baseline by 2018 and only 0.2% lower by 2021.

Assumption Transmission Channel Impact

Le Pen introduces new fiscal program

Fiscal stimulus includes higher R&D and infrastructure

spending, a reduction of red tape,

corporate taxes and employer’s social security

contributions, as well as policies to boost household

purchasing power

Partial offset to decline in French consumption

and investment expenditure

Bond market stress ensues in France and peripheral

Eurozone economies, with yields spiking sharply

higher; credit conditions tighten

Attractiveness of domestic investment declines,

accompanied bya drop-off in inward FDI

Sell-off in European equities

Negative wealth effects and a higher cost of

capital further dampen business and consumer

spending

A weaker euro adds to inflationary pressures Higher inflation dampens consumer spending

Exports outside the EU are more competitive

Net trade improves as exporters benefit from

improved competitiveness, with imports

additionally dampened by weaker domestic

demand environment.

Inward migration from outside the EU is reduced in

France, but changes for other EU member states are

limited

Reduction in labour supply leads to lower

potential output in the France.

Outisde France, fiscal stimulus remains limitedNo boost to aggregate demand from looser

fiscal policy

Weaker consumer spending and business

investment due to confidence shock.

Reduced domestic demand; weaker

investment also weighs on potential growth

The euro depreciates sharply

Marine Le Pen wins the French

Presidential election, with Front

National then securing a majority in the

French parliament. Le Pen calls into

question the future of both the single

currency and single market.

Populist policies take hold in France

Investor sentiment deteriorates amid

heightened uncertainty over Europe's

future and propects for free trade

Business and consumer confidence is hit in France and

other Eurozone economies.


14

Japan is also only moderately affected, despite a strengthening yen. Japanese GDP is 0.5% below

baseline in 2018.

Emerging markets are less affected by trade and financial spill overs from the Eurozone.

Emerging market GDP is 0.3% below baseline in 2018, although some commodity exporters are hit

harder given the weaker world price of oil and more vulnerable economies experience heightened

balance sheet pressure in the face of a strengthening dollar.

Global growth slows to 2.5% in 2017 and 2018, compared with 2.6% and 2.9% in the baseline.

Figure 2.A: Cross-country GDP impact of ‘Le Pen victory sparks Eurozone crisis’ scenario

Commodity and asset market results

The commodity and asset market results of this scenario may be summarised as follows:

Commodity prices fall as a result of weaker global demand. The world price of oil is on average 11%

lower.

Central banks in advanced economies adopt a slower pace of monetary tightening, with the ECB

delaying its first rate hike to beyond 2021. The Fed slows the pace of its monetary tightening, with the

Federal funds rate averaging 0.75% in 2018, 0.7pp lower than the baseline. It then begins to accelerate

the pace of tightening, bringing the policy rate close to baseline levels by the end of the scenario.

Advanced-economy long term bond yields diverge. The Eurozone experiences an initial spike in

sovereign yields and, with public finances continuing to deteriorate in countries such as France and Italy,

risk premia remain higher even after the crisis has passed. But US and Japanese yields decline amid

safe haven inflows, falling 0.4 and 0.2pp below baseline on average.

Equity prices in advanced economies decline sharply, with the Eurozone periphery and France

most affected. Other Eurozone economies and the UK also experience sharp falls in equity prices. The

US and Japan see less severe falls, and are somewhat cushioned by declining long term yields.


15

Figure 2.B: Cross-country GDP impact of ‘Le Pen victory sparks Eurozone crisis’ scenario

-1.8 -1.6 -1.4 -1.2 -1 -0.8 -0.6 -0.4 -0.2 0

ItalySpain

PortugalGreeceFrance

MaltaEurozone

Slovak RepublicCzech Republic

PolandSloveniaHungary

NetherlandsFinlandIreland

BelgiumRussia

DenmarkSwedenAustria

RomaniaQatar

UKGermany

KuwaitEstoniaNorway

SingaporeSouth KoreaHong Kong

BahrainZambiaGhana

LuxembourgSaudi Arabia

MoroccoLithuania

JapanVenezuela

BrazilSwitzerland

MauritiusOman

South AfricaTunisia

USTaiwan

ChinaCroatia

BulgariaNigeria

CanadaNamibia

PeruIsrael

TurkeyKenya

ChileVietnamEcuador

IraqNew Zealand

AlgeriaIndonesia

IndiaArgentinaThailandUruguay

IranAustraliaUgandaMexico

UAECyprus

MalaysiaEgypt

ColombiaLatvia

PakistanPhilippines

Angola

Advanced

Emerging

World: GDP - Le Pen victory sparks Eurozone crisis

Source : Oxford Economics

% difference in level of GDP versus baseline, 2018

Note: Data in the chart rounded to the nearest 0.1.


16

Figure 2.C: Cross-country bond yields impact of ‘Le Pen victory sparks Eurozone crisis’ scenario

-1 -0.5 0 0.5 1 1.5 2

Mexico

South Africa

Malaysia

South Korea

Denmark

Saudi Arabia

Taiwan

US

Hong Kong

Australia

Philippines

Canada

Thailand

China

India

Singapore

Chile

Indonesia

UK

Argentina

Japan

Bulgaria

Switzerland

Brazil

Sweden

Finland

Romania

Croatia

Netherlands

Norway

Turkey

Russia

Slovak Republic

Germany

Czech Republic

Austria

Belgium

Ireland

Hungary

Poland

Eurozone

France

Greece

Spain

Portugal

Italy

Advanced

Emerging

World: Long-term government bond yields - Le Pen victory sparks Eurozone crisis


% difference in level of long-term government bond yields versus baseline, 2018



17

Chart 2.1: World GDP Chart 2.2: French GDP

-3

-2

-1

0

1

2

3

4

5

2007 2009 2011 2013 2015 2017 2019 2021

World: GDP% year

Baseline

Forecast


Source : Oxford Economics/Haver Analytics

-5

-4

-3

-2

-1

0

1

2

3

4

2007 2009 2011 2013 2015 2017 2019 2021

France: GDP% year

Baseline

Forecast



Chart 2.3: Eurozone GDP Chart 2.4: Eurozone investment

-6

-5

-4

-3

-2

-1

0

1

2

3

4

5

2007 2009 2011 2013 2015 2017 2019 2021

Eurozone: GDP% year

Baseline

Forecast



-15

-10

-5

0

5

10

2007 2009 2011 2013 2015 2017 2019 2021

Eurozone: Investment% year

Baseline

Forecast



Chart 2.5: France government debt to GDP ratio Chart 2.6: Eurozone inflation

0

20

40

60

80

100

120

2007 2009 2011 2013 2015 2017 2019 2021

France: Government debt to GDP ratio %

Baseline

Forecast



-1

-0.5

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

2007 2009 2011 2013 2015 2017 2019 2021

Eurozone: Inflation% year

Baseline

Forecast




18

0

5

10

15

20

25

30

35

2007 2009 2011 2013 2015 2017 2019 2021

Eurozone: Quantitative easing% of GDP


Forecast


Baseline

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

2007 2009 2011 2013 2015 2017 2019 2021

Eurozone: Policy rate%

Baseline

Forecast



Chart 2.9: Eurozone exchange rate Chart 2.10: Eurozone equity prices

Chart 2.7: Eurozone quantitative easing Chart 2.8: Eurozone policy rate

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

2

2.2

2007 2009 2011 2013 2015 2017 2019 2021

UK: Exchange rate$/£

Baseline

Forecast


Depreciation


Chart 2.11: UK exchange rate Chart 2.12: Eurozone bond yields (selected countries)

0.6

0.8

1

1.2

1.4

1.6

1.8

2007 2009 2011 2013 2015 2017 2019 2021

Eurozone: $/€$/€

Baseline

Forecast



Depreciation

-2

0

2

4

6

8

10

2016 2017 2018 2019 2020 2021

Greece

Germany

Portugual

Spain

Italy

France

10-year government bond yields%


Le Pen victory

Le Penbacks down

1500

2000

2500

3000

3500

4000

4500

5000

2007 2009 2011 2013 2015 2017 2019 2021

Eurozone: Equity prices1991 = 100

Baseline

Forecast




19

0

1

2

3

4

5

6

2007 2009 2011 2013 2015 2017 2019 2021

US: Policy rate%

Baseline

Forecast



0

1

2

3

4

5

6

2007 2009 2011 2013 2015 2017 2019 2021

US: 10-year government bond yields%

Baseline

Forecast



Chart 2.13: US policy rate Chart 2.14: US bond yields

-8

-6

-4

-2

0

2

4

6

8

10

12

2007 2009 2011 2013 2015 2017 2019 2021

Current account balances% of GDP

Germany

Forecast


Japan

US

China (4-quarter moving average)

Baseline


0

50

100

150

200

250

2007 2009 2011 2013 2015 2017 2019 2021

World: Non-oil commodity prices2005 = 100

Baseline



Forecast

Chart 2.15: Current account balances Chart 2.16: Non-oil commodity prices

Chart 2.17: World oil prices Chart 2.18: World inflation

0

20

40

60

80

100

120

140

160

2007 2009 2011 2013 2015 2017 2019 2021

World oil prices$/barrel

Baseline

Forecast



0

1

2

3

4

5

6

7

8

2007 2009 2011 2013 2015 2017 2019 2021

World: CPI% year

Baseline

Forecast




20

3 Bond market sell-off

The surge in bond yields and sustained dollar strength since the US presidential election have raised

concerns that tightening financial conditions could choke the US recovery before the expected fiscal

stimulus comes to pass. Our previous analysis suggests that these fears are overdone for now, but

that risks are likely to materialise if the bond rout continues. This scenario explores these risks.

In the scenario, inflationary pressures prompt the Fed to raise rates more quickly, hiking four times during

2017. With investors reassessing the future pace of tightening, and term premia edging up from historically

low levels, US Treasury yields surge higher. The shock spills over to global markets: bond yields spike up,

the dollar makes further gains and world equity prices fall.

The economic impact varies across countries. In the US, credit conditions tighten as short- and long-term

rates rise, weighing on domestic demand. But the shock is buffered as the Fed slows its pace of tightening

from 2018 and fiscal stimulus comes on stream. Other advanced economies – while facing higher yields and

a weaker trade outlook – are also able to cushion the blow by keeping policy rates lower for longer.

But many emerging market economies are forced to raise rates in an attempt to staunch capital outflows and

defend their currencies. Worst hit are those, such as Malaysia and Venezuela, that are vulnerable to a

stronger dollar and weaker commodity prices.


Assumptions


Inflation rises above baseline during 2017 in the US in particular, but more generally across

advanced economies. Amid mounting inflationary pressures, US PCE inflation unexpectedly rises

above the Fed’s 2% target.

Against this background, the Fed implements four 25 basis point rate hikes during 2017, a faster

pace of tightening than assumed in the baseline.

US-Treasury yields climb higher amid rising inflation expectations, rising term premia and

investor reassessment of the Fed’s likely reaction to higher inflation. Yields reach 4% during Q4

2017 (compared to 2.8% in the baseline).

Dollar strength continues, with the broad based effective dollar exchange rate strengthening by

around 7% during the year to Q4 2017 (more than twice the appreciation assumed in the baseline).

Compared with previous tightening cycles over the past 60 years, this sits above the average peak rise

(4.2%) but below the appreciations seen during the tightening cycles of 1980-81 (15.2%) and 1984

(8.5%) when fiscal policy was also loosened significantly.

The attractiveness of emerging market assets declines as the US dollar strengthens across the

board and US interest rates increase. Capital flows from emerging markets to the US, amid investor

concerns over the impact on EM balance sheets and less incentive to ‘hunt for yield’.

In the US, the S&P 500 index is assumed to fall by 8% peak to trough, in line with previous

episodes of policy tightening.




21

Table 3.1: Transmission of ‘Bond market sell-off’ scenario



Overall, world GDP growth slows to 2.2% in 2018 (compared with 2.9% in the baseline) but begins to

recover thereafter, rising to 2.5% in 2019 (2.8% in the baseline). In level terms, world output is almost

1% below baseline by 2018.

The countries that suffer the largest hits to GDP are:

Vulnerable EMs, which are adversely affected by dollar strength and higher US interest rates.

Many experience capital outflows and greater currency depreciation than in the baseline,

forcing many to raise interest rates. The level of GDP in Argentina, Brazil, Mexico, Turkey and

Venezuela is roughly 1.7% below baseline in 2018.

The US, as domestic demand is hit by tightening credit conditions amid rising rates and falling

equity prices, at the same time as export recovery is choked off by the resurgent dollar.

Overall, the level of US GDP is around 1% below baseline in 2018 and ends the five-year

forecast horizon 0.7% lower.

Commodity producers, as the global price of oil falls on the back of weaker demand and a

stronger dollar.


US bond market rout continues amid

increased concerns over US

inflationary pressures, rising term

premia and investor reassessment

of the Fed's likely reaction to higher

inflation.

With inflation rising above target,

the Fed proceeds with four 25bp

rate hikes during 2017, a faster pace

of tightening than assumed in the

baseline

A stronger dollar weighs on US

competitivenessUS net trade is adversely affected

Downwards pressure on global commodity

prices Weaker growth for commodity exporters

Capital flows from emerging markets to the

US, amid investor concerns over the impact on

EM balance sheets and reduced incentives to

'hunt for yield'. Policy rates rise in more

vulnerable EMs amid rising inflationary

pressures.

Tighter credit conditions drag on EM growth

Lower path for global equities amid lower

confidence.

Hit to business and consumer spending,

reflecting negative wealth effects, rising

funding costs and greater uncertainty

As the US economy shows signs of

slowing, the Fed slows the pace of

policy normalisation

US bond yields fall back and the dollar softensThe shock to the US and global economy

gradually dissipates

Weaker market sentiment and

tightening financial conditions

Bank lending levels fall backLower lending levels acts as a further drag on

consumer and corporate spending

Higher short-term and long-term rates weigh

on housing and other interest rate-sensitive

sectors of the economy

US domestic demand weakens, reflecting

softness in both consumer spending and

investment

Dollar strength continues


22

Less affected are economies with more limited trade and financial linkages to the US and limited

reliance on global commodity markets.

In the US, growth slows below baseline to 2% in 2017 and 1.8% in 2018. Growth rates recover

from 2019, against a slower pace of Fed tightening and the implementation of fiscal stimulus.

European growth slows. The level of GDP in the Eurozone and the UK is roughly 1% lower than

baseline in 2018, as higher yields and weaker sentiment weigh on spending and global trade slows.

Emerging markets are more vulnerable. The stronger dollar prompts many central banks to raise

policy rates in an attempt to staunch capital outflows and defend their currencies. Among those hardest

hit are Argentina and Venezuela, which see growth slowing in 2018 to 2.5% and 0.9% respectively,

compared with 3.8% and 2.2% in the baseline.

While global inflation surprises on the upside during the early part of the forecast, it falls below

baseline during the latter years as weaker activity is reflected in lower prices. World inflation is 2.8%

in 2020 and 2021 (compared with 3.1% and 3.0% in the baseline).

Figure 3.A: Cross-country GDP impact of ‘Bond market sell-off’ scenario


23



Global energy prices are hit by weaker global demand and the impact of a stronger dollar. The

world oil price is around 10% below baseline in 2018. At the same time, the price of gold rises, peaking at

5% above baseline levels, before moving back towards baseline as the global shock fades.

Relative to the baseline, there is a greater depreciation of emerging market currencies as

investors move away from emerging markets. The Turkish lira and Mexican peso are hit particularly

hard. The Chinese authorities continue to take various measures to stem capital outflows in order to keep

the CNY relatively stable against the US dollar.

Advanced-economy government bond yields rise sharply, with US Treasury yields over 100 basis

points above baseline at the end of 2017. As the global shock to the US and global economy gradually

dissipates, yields generally move back towards baseline levels.

Policy responses vary across regions. Advanced economies are able to slow or postpone policy

tightening in order to cushion the shock, while emerging markets are mostly forced to hike rates to

defend their currencies.

Global equity prices fall on the back of weaker US equities and some contagion to other economies.

The MSCI share price index falls by 8% from peak to trough during 2017, before recovering.


24

Figure 3.B: Cross-country GDP impact of ‘Bond market sell-off’ scenario

-1.8 -1.6 -1.4 -1.2 -1 -0.8 -0.6 -0.4 -0.2 0

Venezuela

Turkey

Brazil

Argentina

Mexico

Qatar

South Africa

Malaysia

Russia

Chile

Kuwait

Oman

UAE

Singapore

Taiwan

China

India

Thailand

Indonesia

Hong Kong

South Korea

Bahrain

Ireland

Netherlands

Finland

Portugal

Greece

UK

Italy

Malta

Denmark

US

Czech Republic

Eurozone

Spain

Slovak Republic

Saudi Arabia

Belgium

Canada

Luxembourg

Romania

France

Germany

Philippines

Norway

Austria

Poland

Sweden

Estonia

Slovenia

Croatia

Hungary

Lithuania

Zambia

Latvia

Namibia

Vietnam

Uruguay

Australia

Switzerland

Morocco

Iran

Iraq

Peru

Pakistan

Bulgaria

Angola

Egypt

Uganda

Kenya

Algeria

Japan

Ghana

Cyprus

Nigeria

New Zealand

Ecuador

Mauritius

Tunisia

Israel

Colombia

Advanced

Emerging

World: GDP - Bond market sell-off





25

Figure 3.C: Cross-country bond yields ‘Bond market sell-off’ scenario

0 0.5 1 1.5 2 2.5

Switzerland

Japan

Denmark

Australia

Sweden

Finland

Netherlands

Austria

Norway

Czech Republic

France

Bulgaria

Germany

Belgium

Slovak Republic

Saudi Arabia

Singapore

Eurozone

Poland

Canada

Ireland

UK

Spain

China

Taiwan

Hong Kong

Romania

Italy

South Korea

Thailand

Croatia

US

India

Philippines

Portugal

Indonesia

Brazil

Hungary

Chile

South Africa

Mexico

Greece

Turkey

Russia

Malaysia

Argentina

Advanced

Emerging

World: Long-term government bond yields - Bond market sell-off


% difference in level of long-term government bond yields versus baseline, 2018



26

0

1

2

3

4

5

6

2007 2009 2011 2013 2015 2017 2019 2021


Baseline

Forecast



Chart 3.1: World GDP Chart 3.2: US GDP

Chart 7.8: US interbank rates

Chart 3.3: US inflation Chart 3.4: US policy rate

Chart 3.5: US equity prices Chart 3.6: US bond yields

-3

-2

-1

0

1

2

3

4

5

2007 2009 2011 2013 2015 2017 2019 2021

World: GDP% year

Baseline

Forecast



-5

-4

-3

-2

-1

0

1

2

3

4

2007 2009 2011 2013 2015 2017 2019 2021

US: GDP% year

Baseline

Forecast



-2

-1

0

1

2

3

4

5

6

2007 2009 2011 2013 2015 2017 2019 2021

US: CPI% year

Baseline

Forecast



0

1

2

3

4

5

6

2007 2009 2011 2013 2015 2017 2019 2021

US: Policy rate%

Baseline

Forecast



0

500

1000

1500

2000

2500

3000

2007 2009 2011 2013 2015 2017 2019 2021

US: Equity prices


Baseline

Forecast

S&P 500 composite index



27

0

1

2

3

4

5

6

7

8

9

2007 2009 2011 2013 2015 2017 2019 2021

US: Corporate borrowing rate %

Baseline

Forecast



-0.5

0

0.5

1

1.5

2

2007 2009 2011 2013 2015 2017 2019 2021

Japan: 10-year government bond yields%

Baseline

Forecast



0

1

2

3

4

5

6

2007 2009 2011 2013 2015 2017 2019 2021

Eurozone: 10-year government bond yields%

Baseline

Forecast



0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

2007 2009 2011 2013 2015 2017 2019 2021

Brazil: Exchange rateReal/$

Baseline

Forecast



Depreciation

0

20

40

60

80

100

120

140

2007 2009 2011 2013 2015 2017 2019 2021

Japan: Exchange rateYen/$

Baseline

Forecast



Depreciation

Chart 3.9: US corporate borrowing rate Chart 3.10: US effective exchange rate

Chart 3.11: Japan exchange rate Chart 3.12: Brazil exchange rate

0

20

40

60

80

100

120

140

160

2007 2009 2011 2013 2015 2017 2019 2021

US: Effective exchange rate1997Q1 = 100

Baseline

Forecast



Chart 3.7: Eurozone bond yields Chart 3.8: Japan bond yields



28

0

1

2

3

4

5

6

7

8

2007 2009 2011 2013 2015 2017 2019 2021

World: CPI% year

Baseline

Forecast





-6

-5

-4

-3

-2

-1

0

1

2

3

4

5

2007 2009 2011 2013 2015 2017 2019 2021


Forecast

Baseline

% year

Eurozone: GDP


-5

-4

-3

-2

-1

0

1

2

3

4

5

6

7

2007 2009 2011 2013 2015 2017 2019 2021


Forecast

Baseline

% year

Emerging Market: GDP


-8

-6

-4

-2

0

2

4

6

8

10

12

2007 2009 2011 2013 2015 2017 2019 2021


Germany

Forecast


Japan

US


Baseline


0

50

100

150

200

250

2007 2009 2011 2013 2015 2017 2019 2021


Baseline



Forecast

0

20

40

60

80

100

120

140

160

2007 2009 2011 2013 2015 2017 2019 2021

World oil price$/barrel

Baseline

Forecast



Chart 3.13: Eurozone GDP Chart 3.14: Emerging market GDP



29

4 Tighter policies in China

While China comfortably met the target of at least 6.5% GDP growth in 2016, a big question for 2017

and beyond is whether the authorities will continue to aim for overly ambitious GDP growth targets

or start to rein in credit to put growth on a more sustainable footing. In this scenario, we consider the

latter possibility.

Under this scenario, China’s policymakers recognise the unsustainability of the current debt trajectory; they

decide to lower their overly ambitious growth targets and they rein in the expansion of credit, supported by

structural reforms to bolster the role of equity financing and the efficiency of the financial sector. Credit

growth is gradually reduced and the ratio of credit to GDP peaks in late 2021. Investment spending is hit in

particular. But, in the absence of abrupt property, equity or FX corrections, spill-overs to the rest of the world

are contained compared with a more adverse scenario.

The overall result is a delay to the anticipated pickup in the pace of global economic expansion. World GDP

growth remains subdued at 2.4% in 2017 and 2.2% in 2018, compared with the baseline rise to 2.6% and

2.9% respectively. But there are marked differences in the impact on GDP across countries. Those that

suffer most are China itself, commodity producers such as Russia and Venezuela, and China’s Asian

neighbours such as Hong Kong and Singapore.

In financial markets, Asian and commodity-exporters’ currencies depreciate, owing to the fall in oil and other

commodity prices and slower growth in the Chinese economy. Advanced-economy government bond yields

weaken as policy rates remain low for longer. And global equity prices weaken, remaining depressed

throughout the forecast period.

We attach a GSS weight of 10% weight to this scenario.

Assumptions


China’s credit-to-GDP ratio peaks in late 2021, reflecting the authorities’ shift in policy away from

overly ambitious growth targets towards reining in leverage. Investment spending slows accordingly.

Financial reforms are implemented to dampen the impact, including measures to improve the

allocation of capital and increase the contribution of equity financing.

Rates of return and non-performing loans both rise. Tighter credit conditions reduce financing of

companies and projects with low profitability. But they also weaken the ability of indebted companies to

roll-over debt, leading to higher NPLs.

The announcement of the new Chinese policy stance causes some initial market disruption. Credit

spreads begin to widen in emerging markets, as capital flows into safe-haven assets, and credit

conditions tighten slightly in advanced economies. However, financial conditions then normalise as it

becomes clear that China can avoid a hard landing of its economy.


30

Table 4.1: Transmission of ‘Tighter policies in China’ scenario



Global activity is moderately impacted. World GDP growth remains subdued at 2.4% in 2017 and

2.2% in 2018, compared with the baseline rise to 2.6% and 2.9% respectively.


China itself, as investment decelerates sharply.

Commodity producers, such as Russia and Venezuela, as oil and other commodity prices

weaken at the same time as global trade growth slows.

China’s Asian neighbours, such as Hong Kong and Singapore, as global trade growth slows.

Less affected are advanced economies with limited reliance on Asian trading partners or

commodity markets.

As a result, growth in China slows steadily, to 5.7% in 2017, 4.6% in 2018 and, with investment growth

dropping below 1% from 2018, remains at or below 5% thereafter. By the end of the decade, output is

almost 4% below baseline, depressing CPI inflation and weakening earnings growth further.

Across emerging markets as a whole, growth slows to 3.7% in 2017 and 3.5% in 2018 (from 4.1%

and 4.5% respectively) and remains around 4% in the latter part of the forecast.

Among advanced economies, Eurozone recovery stalls. GDP growth eases to 1.3% in 2017 and 0.8%

in 2018. In the US, growth also slows, to 2.2% in 2017 and 2.0% in 2018; growth recovers at the end of

2019, supported in part by a more sluggish pace of policy tightening than in the baseline (see below).


Shift in policy in China away from

current growth targetsReduction in debt financing Slower investment growth in China

Structural reforms in China,

including improvements in the

allocation of capital

Bank balance sheets strengthen; increased

equity financing

Chinese investment becomes more

sustainable

Initial risk-off reaction to Chinese

policies

Increased credit spreads in emerging markets

and slightly tighter credit conditions in

advanced economies

Weaker consumption and investment growth

globally in the near term


31

Figure 4.A: Cross-country GDP impact of ‘Tighter policies in China’ scenario



Commodity prices are hit in the short term following the announcement of the policy shift in China. Oil

prices are around 10% below baseline at the end of the scenario; metal prices are similarly affected.

With oil prices lower, Venezuela’s capacity to pay deteriorates sufficiently to force a default on

international bonds by 2019 in the absence of Chinese agreement to restructure its bilateral loans again

(currently under a two-year grace period).

Currencies of commodity producers and Asian economies depreciate the most in the near term,

although movements are limited. The Chinese authorities keep the CNY relatively stable against the US

dollar, in order to dampen global spillovers and stem capital outflows.

Advanced-economy government bond yields weaken as policy rates remain low for longer. While

the Fed still hikes rates this year, as global demand weakens it then keeps the Fed funds rate below 1%

until mid-2018. The ECB keeps policy rates low for longer and only begins raising rates in 2021.

Global equity prices weaken. The MSCI world share price index falls around 5% below baseline in

2018; with global demand and earnings subdued, stock markets remain below baseline throughout the

forecast.


32

Figure 4.B: Cross-country GDP impact of ‘Tighter policies in China’ scenario

-2 -1.8 -1.6 -1.4 -1.2 -1 -0.8 -0.6 -0.4 -0.2 0

ChinaHong Kong

ChileTaiwan

VenezuelaIndonesiaAustralia

BrazilMalaysia

SingaporeTurkeyQatar

RussiaCanada

PhilippinesArgentina

South AfricaSouth Korea

JapanVietnamMexico

ThailandKenya

LuxembourgOman

UgandaMalta

NetherlandsEstonia

MauritiusDenmarkHungary

CyprusSlovenia

GhanaZambia

LatviaKuwait

LithuaniaUruguay

Saudi ArabiaUAE

PakistanBahrain

GermanyNigeria

SpainBelgiumFinland

ItalySweden

EurozoneTunisiaAngola

IsraelPolandGreeceAustria

IndiaIreland

NamibiaPortugalCroatia

ColombiaNew Zealand

NorwaySlovak Republic

FranceEgypt

EcuadorUS

SwitzerlandUK

RomaniaBulgaria

Czech RepublicPeruIran

MoroccoIraq

Algeria

Advanced

Emerging

World: GDP - Tighter policies in China





33

Figure 4.C: Cross-country exchange rate impact of ‘Tighter policies in China’ scenario

-3 -2.5 -2 -1.5 -1 -0.5 0 0.5 1 1.5

Brazil

Chile

Russia

Norway

India

China

Australia

Argentina

Singapore

Canada

Taiwan

Indonesia

South Africa

Malaysia

South Korea

Thailand

Turkey

Philippines

Hungary

Hong Kong

US

UAE

Saudi Arabia

Czech Republic

Mexico

Croatia

Romania

Switzerland

Poland

Sweden

Denmark

Japan

UK

Eurozone

Bulgaria

Advanced

Emerging

World: US dollar exchange rates - Tighter policies in China


Depreciation

% difference in level of US dollar exchange rates versus baseline, 2018



34

-30

-20

-10

0

10

20

30

40

50

2007 2009 2011 2013 2015 2017 2019 2021

China: Exports

Baseline

Forecast


% year


0

2

4

6

8

10

12

14

16

2007 2009 2011 2013 2015 2017 2019 2021

China: GDP

Baseline

Forecast

Tighter policies in China weigh

on global growth

% year


0

5

10

15

20

25

30

2007 2009 2011 2013 2015 2017 2019 2021

China: Investment

Baseline Forecast


% year


-3

-2

-1

0

1

2

3

4

5

2007 2009 2011 2013 2015 2017 2019 2021

World: GDP

Baseline

Forecast


% year


-5

-4

-3

-2

-1

0

1

2

3

4

2007 2009 2011 2013 2015 2017 2019 2021

US: GDP

Baseline

Forecast


% year


Chart 4.1: Chinese Investment Chart 4.2: Chinese GDP


Chart 4.3: Chinese exports Chart 4.4: Hong Kong exports

Chart 4.5: US GDP Chart 4.6: World GDP

-25

-20

-15

-10

-5

0

5

10

15

20

25

2007 2009 2011 2013 2015 2017 2019 2021

Hong Kong: Exports

Baseline

Forecast


% year



35

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

2007 2009 2011 2013 2015 2017 2019 2021

Emerging market: Risk premium

Baseline

Forecast


%


-1

0

1

2

3

4

5

2007 2009 2011 2013 2015 2017 2019 2021

Eurozone: Policy rate%

Baseline

Forecast



0

1

2

3

4

5

6

2007 2009 2011 2013 2015 2017 2019 2021

US: Policy rate%

Baseline

Forecast



20

30

40

50

60

70

80

2007 2009 2011 2013 2015 2017 2019 2021

Russia: Ruble/$

Baseline

Forecast


Ruble/$


Depreciation

1

1.5

2

2.5

3

3.5

4

4.5

2007 2009 2011 2013 2015 2017 2019 2021

Brazil: Real/$

Baseline

Forecast


Real/$


Depreciation

Chart 4.9: Emerging market interest rates Chart 4.10: Chinese exchange rate

Chart 4.11: Brazilian exchange rate Chart 4.12: Russian exchange rate

5

5.5

6

6.5

7

7.5

8

2007 2009 2011 2013 2015 2017 2019 2021

China: Yuan/$

Baseline

Forecast


Yuan/$


Depreciation

Chart 4.7: US policy rate Chart 4.8: Eurozone policy rate


36

-8

-6

-4

-2

0

2

4

6

8

10

12

2007 2009 2011 2013 2015 2017 2019 2021


Germany

Forecast


Japan

US



Baseline

0

1

2

3

4

5

6

2007 2009 2011 2013 2015 2017 2019 2021

US: 10-Year government bond yields%

Baseline

Forecast



0

500

1000

1500

2000

2500

3000

2007 2009 2011 2013 2015 2017 2019 2021

US: EquityS&P 500 composite index

Baseline

Forecast



0

1

2

3

4

5

6

7

8

2007 2009 2011 2013 2015 2017 2019 2021

World: CPI% year

Baseline

Forecast



0

20

40

60

80

100

120

140

160

2007 2009 2011 2013 2015 2017 2019 2021


Baseline

Forecast





0

50

100

150

200

250

2007 2009 2011 2013 2015 2017 2019 2021


Baseline



Forecast

Chart 4.13: US equity prices Chart 4.14: US bond yields


37

5 Trump presidency weighs on global growth

In our adverse Trump scenario, we assume that, the new president adopts a highly protectionist and

isolationist stance, fails to implement a significant fiscal stimulus package and proceeds with

immigration curbs and deportations that result in substantial labour force declines. Against a

backdrop of heightened uncertainty, the US and global economies are badly shaken.

On trade, Trump proceeds with his proposed 35% and 45% trade tariffs on Mexico and China in H2 2017

and maintains them throughout his presidency; further tariffs are also imposed on South Korea and Taiwan.

These trading partners retaliate by matching the tariffs imposed by the US.

Trump’s refusal to negotiate on his extreme trade proposals means that the Republicans maintain a deficit-

neutral stance on the budget. The resulting fiscal package involves $500 billion of tax cuts over the next ten

years—a less substantial, more regressive policy change than in the baseline and matched by offsetting

revenues and spending cuts. The $200 billion infrastructure stimulus assumed in our baseline forecast also

fails to materialise.

The economic and market implications are profound. By late-2019, the US economy has entered recession;

by 2021 the economy is 6% smaller than in the baseline forecast. As the impact of Trump’s policies spills

over, the global recovery is undermined, with world growth only returning to baseline at the very end of the

five-year forecast. Commodity and asset market impacts are similarly marked, with oil prices weaker and

substantial movements in both policy rates and yields.


Assumptions

The main assumptions of this scenario are as follows:

Business and consumer confidence are dented both in the US and globally. We assume confidence

effects roughly equal to 10% of the scale experienced during the global financial crisis, which gradually

fade over the course of President-elect Trump’s administration.

Global financial markets show some modest safe-haven flight, with emerging market currencies

weakening and the euro and yen strengthening against the dollar relative to the baseline over the

course of 2017.

We have not incorporated the Border Tax Adjustment proposal contained in House Ways & Means

Committee Chairman Brady’s tax blueprint.

But, from Q3 2017, we assume that the US imposes 45% and 35% tariffs on Chinese and Mexican

merchandise goods respectively – and then, as US consumers switch away from higher-priced Mexican

and Chinese imports, the US raises 20% tariffs on South Korea and Taiwan.

Mexico, China, South Korea and Taiwan all retaliate with similar tariffs on US exports.

With the Republicans maintaining a deficit-neutral stance, the final fiscal package is more limited than

assumed in the baseline-—$500 billion of tax cuts over the next ten years, with offsetting revenues and

back-loaded spending cuts. The composition of the tax cuts is also more regressive than assumed in the

baseline. In addition, the $200 billion infrastructure stimulus assumed in our baseline forecast fails

to materialise.

Deportation of illegal immigrants and curbs on legal immigrants result in a marked decline in the

US labour force. Towards the end of the five-year forecast, after the end of the four-year presidential




38

term, labour supply growth is assumed to rise back towards its baseline rate. But, by then, the US labour

force is already nearly 3 million below its baseline level.

Table 5.1: Transmission of ‘Trump presidency weighs on global growth’ scenario




The US itself, as domestic demand weakens amid heightened uncertainty, slowing population

growth, rising consumer price inflation and increasingly contractionary fiscal effects, at the same time

as exports falter under the weight of increased trade barriers and slowing global trade.

Mexico and China, as exports decline in the face of US tariffs. This weighs on employment and,

with investment scaled back, domestic demand.

Asian economies more generally, reflecting increased concerns that the US might impose tariff

hikes more widely and the impact on global trade of the decline in trade between the world’s two

largest economies.

Commodity exporters, albeit to a lesser extent as global demand weakness weighs on oil and other

commodity prices.

While all countries are adversely affected, impacts are generally more muted among commodity

importers in advanced economies.

In the US, growth slows below baseline in 2017 (to 1.6%) and 2018 (1.0%). Initial confidence and

market impacts weigh modestly on growth, offset to some extent by weaker imports, the implementation

of tax cuts and the maintenance by the Fed of an accommodative policy stance.

But US growth slows more severely in the latter part of the forecast. Retaliatory tariffs from China

and Mexico eventually take a harsh toll on US export growth, and aggregate demand (and supply) is lost


More protectionist trade policiesLower exports for tariffed countries, as well as

other countries as global trade slows.

Lower aggregate demand. Higher inflation in

countries which establish tariffs

Contractionary US fiscal policy compared to the

baseline, with tax cuts half the size of our central

assumption and the assumed infrastructural stimulus

failing to materialise

Dampened US domestic demand; knock-on

impact on other countries' export demandLower aggregate demand

Greater reduction in US illegal immigration

Increase in population/labour force in

countries recieiving returning migrants;

reduction in US population/labour force

Higher domestic demand and potential growth

in countries receiving returning migrants;

reduced domestic demand and potential

growth in US

Domestic and global confidence shock

Investment and consumption decisions

postponed, exacerbated by impact of lower

equity prices on wealth and cost of capital

Lower domestic demand. Weaker supply

growth as capital accumulation slows

Deterioration in market sentimentLower US and global equity prices; higher

sovereign spreads in EMs affected by tariffs

Dampened business and consumer spending,

reflecting negative wealth effects and rising

cost of borrowing as cost of capital rises and

credit conditions tighten more generally

Reduced openness weighs on productivity

Weaker productivity growth in countries

adopting a less open trade policy, reflecting a

deterioration in resource allocation, weaker

competition and reduced access for domestic

producers to intermediate inputs

Slightly weaker growth in potential supply,

with greater inflationary pressure for a given

level of demand


39

due to the deportation of illegal immigrants. The phasing in of fiscal expenditure cuts also damages

consumer spending. The impact is exacerbated by the inflationary effects of higher import costs.

Reflecting this combination of factors, the US economy fails to expand in 2019 and 2020. While growth

then recovers gradually, the level of US GDP is 6% below baseline in 2021.

The imposition of tariffs damages exports and investment in China and Mexico – and to a lesser

extent South Korea and Taiwan. Chinese growth falls below 5% in 2018 and 2019.

The imposition of tariffs also has important implications for inflation, particularly in Mexico. Mexican

inflation spikes in the near-term, reflecting higher import tariffs and currency depreciation; inflationary

pressures then ease as the import price impact fades, some of the temporary currency weakness

dissipates, and weaker activity puts downward pressure on core inflation.

In the Eurozone and Japan, currency appreciation and weaker global demand weigh on net trade.

Growth in the Eurozone slows to 1.2% in 2017 and 0.9% in 2018, before slowly picking up. Japan

achieves growth of 0.9% and 0.6% in these two years.

Global growth slows to 2.2% (from 2.6% in the baseline) in 2017, 1.9% (2.9%) in 2018 and 2.0% (2.8%)

in 2019.

Figure 5.A: Cross-country GDP impact of ‘Trump presidency weighs on global growth’ scenario


40

Commodity and asset price results

The commodity and asset price results of this scenario may be summarised as follows:

Oil and commodity prices are weighed down over the scenario by weaker global demand. At their peak,

oil prices are some 18% lower than our baseline.

The yen and the euro strengthen significantly in the short term compared to baseline. In 2018, the

yen and euro are 3-4% stronger against the dollar. While generally weakening against advanced

economies, the dollar appreciates against emerging market currencies; as a result, the dollar is a little

stronger than in the baseline on a (broad-based) trade-weighted basis.

The Fed initially raises the Fed funds rate in line with the baseline forecast. But it then adopts a

cautious stance as the US economy slows, pausing its tightening cycle during 2017 and then

bringing the policy rate back towards the effective lower bound. This reflects the anticipated drag

from weaker growth on core inflationary pressures over the medium term, notwithstanding the inflationary

effects of tariffs and supply-side headwinds.

Advanced-economy government bond yields are similarly subdued. US yields nudge down as policy

rates remain low for longer and safe-haven flows increase amid the heightened uncertainty, more than

offsetting the impact of increased concerns over the US itself.

Global equity prices dip on the back of weaker US equities and a degree of contagion to other

economies.


41

Figure 5.B: Cross-country GDP impact of ‘Trump presidency weighs on global growth’ scenario

-3 -2.5 -2 -1.5 -1 -0.5 0

MexicoChina

HungaryUS

MalaysiaLuxembourg

Hong KongMalta

KuwaitSweden

DenmarkSouth Korea

NorwayOman

Saudi ArabiaPoland

VenezuelaLatvia

BahrainCroatia

BelgiumIran

NetherlandsItaly

Czech RepublicLithuania

JapanIreland

IndiaIraq

AngolaAustriaNigeria

GermanyChile

PakistanEgypt

TurkeySpain

EstoniaPhilippines

AlgeriaEurozoneAustralia

New ZealandSloveniaMauritius

CanadaFinlandRussiaCyprus

QatarTaiwan

South AfricaVietnamNamibia

BrazilIsraelPeru

SwitzerlandGreece

EcuadorIndonesia

UAERomania

FranceThailand

Slovak RepublicUK

UruguaySingaporeArgentinaColombiaPortugalBulgariaZambiaKenya

MoroccoUgandaTunisiaGhana

Advanced

Emerging

World: GDP - Trump presidency weighs on global growth





42

Figure 5.C: Cross-country country exchange rate impact ‘Trump presidency weighs on global

growth’ scenario

-20 -15 -10 -5 0 5 10

Mexico

Australia

Chile

Argentina

South Africa

Russia

Brazil

India

Philippines

Canada

China

Thailand

Indonesia

South Korea

Malaysia

Taiwan

Singapore

Hong Kong

US

UAE

Saudi Arabia

Turkey

UK

Japan

Romania

Norway

Sweden

Hungary

Poland

Czech Republic

Croatia

Denmark

Switzerland

Bulgaria

Eurozone

Advanced

Emerging

World: US dollar exchange rates - Trump presidency weighs on global growth


Depreciation




43

-3

-2

-1

0

1

2

3

4

5

2007 2009 2011 2013 2015 2017 2019 2021

World: GDP% year

Baseline

Trump presidency weighs on global growth


Forecast

-5

-4

-3

-2

-1

0

1

2

3

4

2007 2009 2011 2013 2015 2017 2019 2021

US: GDP% year

Baseline



Forecast

-2

-1

0

1

2

3

4

5

6

2007 2009 2011 2013 2015 2017 2019 2021

US: CPI inflation% year

Baseline



Forecast

-20

-15

-10

-5

0

5

10

15

2007 2009 2011 2013 2015 2017 2019 2021

US: Exports% year

Baseline



Forecast

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2007 2009 2011 2013 2015 2017 2019 2021

US: Labour supply% year


Baseline

Forecast


-12

-10

-8

-6

-4

-2

0

2007 2009 2011 2013 2015 2017 2019 2021

US: Budget balance% of GDP

Baseline



Forecast


Chart 5.3: US exports Chart 5.4: US inflation

Chart 5.5: US unified budget balance Chart 5.6: US labour supply


44

-8

-6

-4

-2

0

2

4

6

8

2007 2009 2011 2013 2015 2017 2019 2021

Mexico: GDP% year

Baseline



Forecast

0

1

2

3

4

5

6

7

2007 2009 2011 2013 2015 2017 2019 2021

Mexico: CPI inflation% year

Baseline



Forecast

0

2

4

6

8

10

12

14

16

2007 2009 2011 2013 2015 2017 2019 2021

China: GDP% year

Baseline



Forecast

10

12

14

16

18

20

22

24

26

2007 2009 2011 2013 2015 2017 2019 2021

Mexico: Exchange ratePeso/$

Baseline

Forecast



Depreciation

0

1

2

3

4

5

6

2007 2009 2011 2013 2015 2017 2019 2021

US: Policy rate%

Baseline



Forecast

-4

-2

0

2

4

6

8

10

2007 2009 2011 2013 2015 2017 2019 2021

China: CPI inflation% year

Baseline



Forecast

Chart 5.9: Mexican exchange rate Chart 5.10: Chinese GDP

Chart 5.11: Chinese inflation Chart 5.12: US policy rate

Chart 5.7: Mexican GDP Chart 5.8: Mexican inflation


45

0

500

1000

1500

2000

2500

3000

2007 2009 2011 2013 2015 2017 2019 2021

US: Equity prices


Baseline

Forecast



0

50

100

150

200

250

2007 2009 2011 2013 2015 2017 2019 2021


Baseline



Forecast

-8

-6

-4

-2

0

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12

2007 2009 2011 2013 2015 2017 2019 2021


Germany

Forecast


Japan

US


Baseline


0

1

2

3

4

5

6

7

8

2007 2009 2011 2013 2015 2017 2019 2021

World: CPI% year


Baseline

Forecast


20

40

60

80

100

120

140

2007 2009 2011 2013 2015 2017 2019 2021



Baseline

Forecast




Chart 5.13: US bond yields Chart 5.14: US equity prices

0

1

2

3

4

5

6

2007 2009 2011 2013 2015 2017 2019 2021


Baseline



Forecast


46

6 US growth surges amid Trump fiscal stimulus

While our first Trump scenario examines an adverse outcome for the US economy, a possibility

highlighted by the latest Oxford Economics Global Risk Survey is that the result of congressional

negotiations is far more stimulatory. In particular, a greater relaxation of fiscal orthodoxy might be

achieved in exchange for a less protectionist stance than the new president campaigned on, as we

explore in our upside Trump scenario.

In this scenario, the result of congressional negotiations is significantly more expansionary than assumed in

the baseline. The fiscal package is larger, with $2 trillion worth of personal income and corporate tax cuts

and a $250 billion public infrastructure investment plan. In exchange, Trump refrains from imposing trade

restrictions.

As a result, the US economy grows more quickly than in the baseline. It benefits not only from the initial

impact of lower taxes and increased infrastructure spending, but also increased confidence in Trump and his

team’s ability to govern. In 2017, growth edges up to 2.5% (2.3% in the baseline); in 2018, when the boost

from fiscal stimulus and private sector confidence peaks, growth reaches 3.6% (compared with 2.5%).

The global economy grows more quickly as stronger US growth spills over, fears over increased

protectionism dissipate and confidence improves. World growth reaches 2.7% in 2017 and 3.3% in 2018,

0.1-0.4pp above baseline. But the impact varies widely across countries, reflecting policy and market

developments. Economies around the world benefit from renewed confidence, stronger global trade and

more buoyant equity markets. But, as the Fed brings forward its tightening cycle (with the ECB and Bank of

England following suit), a stronger dollar and higher US interest rates reduce the attractiveness of emerging

market assets. As capital flows from emerging markets to the US amid investor concerns over the impact on

emerging market balance sheets and reduced incentives to 'hunt for yield', credit conditions tighten in more

vulnerable emerging market economies and the boost to activity is at least partially tempered.

We assign a Global Scenarios Service (GSS) weight of 25% weight to this scenario.

Assumptions

The main assumptions of this scenario are as follows:

The US embarks on fiscal loosening. A $2 trillion package of tax cuts is agreed with Congress

(compared with $1 trillion in the baseline), with 60% aimed at lowering personal income taxes and 40%

accounted for by lower corporate taxes.

Tax cuts are implemented in late-2017 and have the greatest impact in FY2018.

Along with the tax cuts, we assume Congress passes a $250 billion public infrastructure investment

plan (compared with $200 billion in the baseline).

The offset from cuts to government outlays are a little larger than in our baseline ($350 billion compared

with $300 billion), but the government spending cuts are even more back-loaded in the decade. The

offsetting revenues come as a one-time tax holiday on foreign earnings and carried interest income, as in

the baseline, but we also assume a repeal of some corporate tax expenditures.

Trump pursues a less protectionist stance than he campaigned on and refrains from imposing trade

restrictions.

Post-election uncertainty dissipates quickly. Confidence in Trump and his team’s ability to govern

increases, peaking in 2018 for US businesses, and confidence improves globally.





47

The Fed adopts a more rapid pace of policy tightening as the outlook for the US economy improves

and inflationary pressures start to build. Rates are hiked three to four times in each of 2018 and 2019, a

faster pace than assumed in the baseline.

The attractiveness of emerging market assets declines as the US dollar strengthens across the

board and US interest rates rise. Capital flows from emerging markets to the US, amid investor

concerns over the impact on EM balance sheets and reduced incentives to 'hunt for yield'.

Among advanced economies, currency depreciation for Japan and Europe results in a further boost

to export demand, adding to the support from stronger global trade.

Table 6.1: Transmission of ‘US growth surges amid Trump fiscal stimulus’ scenario

Table 6.1: Transmission of the ‘US growth surges amid Trump fiscal stimulus’ scenario


Tax reductions are twice as large as in the

baseline

Increase in personal income leads to greater

private consumption

The government implements a larger

infrastructure investment programHigher domestic demand

Fiscal loosening is debt financed

Initial worsening of government balance,

increasingly mitigated by higher tax revenues

as growth picks up

Worsening of fiscal position is only limited

Less scope for trade retaliation, protecting US

exporters

US maintains mutually beneficial strong trade

ties with the rest of the World

Increased deportations of illegal

immigrants would be limited

Population and working population above

baselineSupportive for long-term growth

As the economy improves,

confidence in President Trump and

his team’s ability to govern

increases

Uncertainty dissipates quickly, limiting impact

on consumer and business investment

demand, and confidence improves

Global positive confidence shock provides

second-round effects enhancing demand, as

well as supply growth as capital accumulation

accelerates

Monetary policy less

accommodative than in the baseline

In this environment, the Fed would most likely

judge the labor market progress and building

inflationary pressures as sufficient

justification for three rate hikes in 2017.

Thereafter, the Fed would adopt a more

hawkish stance with three to four rate hikes in

each of 2018 and 2019

Inflation remains under control, credit

conditions tighten slightly, long-term bond

yields rise across the board.

A strengthening dollar and higher

dollar interest rates reduces the

attractiveness of emerging market

assets

Capital flows from emerging markets to the

US, amid investor concerns over the impact on

EM balance sheets and reduced incentives to

'hunt for yield'

The impact of stronger global demand on EMs

is at least partially tempered by tightening

credit conditions, particularly in more

vulnerable EMs

US embarks on fiscal loosening with

a particular focus on tax reductions

and public investment

In exchange for relaxation on fiscal

orthodoxy, Trump adopts less

protectionist trade stance than he

campaigned on

Stronger US export growth and healthier world

trade growth; Less retaliation benefits

consumers


48



The countries that experience the largest boost to GDP are:

The US itself, which benefits initially from not only the initial impact from lower taxes and increased

infrastructure spending, but also increased confidence in President Trump and his team’s ability to

govern. Overall, the level of US GDP rises 2.2% above baseline by the end of the five-year forecast;

the level of employment is some 1.8 million higher.

Canada, the US’s closest trading partner. By the end of the five-year forecast, the level of GDP is

around 1% higher than in the baseline forecast.

China, which benefits from increased confidence as fears over US protectionism dissipate, as well

as increased demand from the US market and increased global demand more generally. By the end

of the five-year forecast, its level of GDP is 1.9% higher than in the baseline.

Other Far Eastern countries that benefit from increased confidence and the recovery in global

trade growth. Countries such as Hong Kong and Taiwan grow a little more rapidly than in the

baseline for much of the forecast; by 2021, the level of GDP lies 1.1-1.2 percentage points above

baseline.

Mexico, which benefits from increased demand from its largest export market and increased

confidence as fears over US protectionism dissipate.

The economies that benefit least are emerging market economies vulnerable to a stronger US

dollar and higher US interest rates. South Africa and Turkey, for example, fail to reap the benefits of a

stronger global economy.

In the US, growth rises above baseline. In 2017, growth picks up to 2.5% (compared with 2.3% in the

baseline); in 2018, when the boost from fiscal stimulus and private sector confidence peaks, growth

reaches 3.6% (compared with 2.5%).

Among the advanced economies, Japan and Europe fare moderately well, as currency depreciation

combines with stronger global trade to growth to support export growth. Growth in the Eurozone

remains around 1.7% in 2017 and 1.8% 2018, 0.2-0.3 percentage points above baseline; Japanese

growth receives a similar boost, edging up to 1.4% in 2017 and 1.7% in 2018.

Among emerging market economies, commodity exporters are also positively affected, boosted to

some extent by increased commodity demand that pushes up oil and other commodity prices.

World growth reaches 3.4% in 2018, 0.5 percentage points above baseline.


49

Figure 6.A: Cross-country GDP impact of ‘US growth surges amid Trump fiscal stimulus’ scenario



Oil and other commodity prices gradually edge higher. By 2021, oil prices and metals prices are 5-6%

higher than our baseline.

The US dollar strengthens across the board, remaining 1-2% above baseline on an effective trade-

weighted basis over the course of the scenario period. The currencies of vulnerable emerging market

economies depreciate the most.

The faster pace of Fed rate hikes (see above) is accompanied by an earlier start to the policy

tightening cycle in some other major advanced economies. In the Eurozone, for example, the ECB

raises its deposit rate in 2019.

Advanced-economy government bond yields pick up, particularly in the US. US 10-year yields rise

0.4-0.6 percentage points above the baseline profile in 2018 and 2019, as both US growth and Fed policy

tightening gathers pace. Eurozone and UK yields also edge above the baseline path, albeit much less

markedly.

Global equity prices are buoyant on the back of the improved global economic backdrop. Gains

are most marked in the US, where the S&P rises 7% above baseline in 2018; Canada and China notch

up 5-6% gains relative to baseline.


50

Figure 6.B: Cross-country GDP impact of ‘US growth surges amid Trump fiscal stimulus’ scenario

0 0.2 0.4 0.6 0.8 1 1.2 1.4

South AfricaTurkeyKenyaMalta

UgandaUAE

BelgiumAlgeria

EcuadorSlovak Republic

UruguayGreece

IranIndia

EgyptHungary

QatarBulgaria

LuxembourgPakistan

IraqGhana

MoroccoCyprus

MauritiusNamibiaPortugal

KuwaitIsrael

NigeriaColombia

RussiaAustriaZambiaTunisia

SloveniaSaudi Arabia

AngolaSpain

NetherlandsSwitzerland

New ZealandCzech Republic

FinlandRomaniaLithuania

LatviaAustralia

PeruEstonia

EurozoneDenmark

FranceNorway

GermanyCroatiaMexico

ItalySweden

SingaporeMalaysia

PolandUK

OmanJapan

ThailandArgentina

PhilippinesIreland

VietnamVenezuela

BrazilBahrain

IndonesiaChina

South KoreaTaiwan

ChileHong Kong

CanadaUS

Advanced

Emerging

World: GDP - US growth surges amid fiscal stimulus





51

Figure 6.C: Cross-country exchange rate impact of ‘US growth surges amid Trump fiscal stimulus’

scenario

-5 -4 -3 -2 -1 0 1 2

Turkey

Russia

Malaysia

Brazil

Taiwan

China

South Africa

India

South Korea

Indonesia

Australia

Canada

Japan

Eurozone

Bulgaria

Croatia

Singapore

UK

Thailand

Poland

Chile

Denmark

Hungary

Sweden

Switzerland

Romania

Czech Republic

Argentina

Hong Kong

US

Mexico

UAE

Saudi Arabia

Philippines

Norway

Advanced

Emerging

World: US dollar exchange rates - US growth surges amid fiscal stimulus


Depreciation




52

-3

-2

-1

0

1

2

3

4

5

2007 2009 2011 2013 2015 2017 2019 2021

World: GDP% year

Baseline

US growth surges amid fiscal stimulus


Forecast

-5

-4

-3

-2

-1

0

1

2

3

4

5

2007 2009 2011 2013 2015 2017 2019 2021

US: GDP% year

Baseline



Forecast

-20

-15

-10

-5

0

5

10

15

2007 2009 2011 2013 2015 2017 2019 2021

US: Exports% year

Baseline



Forecast

-2

-1

0

1

2

3

4

5

6

2007 2009 2011 2013 2015 2017 2019 2021

US: CPI inflation% year

Baseline



Forecast

-12

-10

-8

-6

-4

-2

0

2007 2009 2011 2013 2015 2017 2019 2021

US: Budget balance%


Baseline

Forecast


-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2007 2009 2011 2013 2015 2017 2019 2021

Baseline


Forecast

% year

US: Labour supply



Chart 6.3: US exports Chart 6.4: US inflation

Chart 6.5: US unified budget balance Chart 6.6: US labour supply


53

0

1

2

3

4

5

6

7

2007 2009 2011 2013 2015 2017 2019 2021

Mexico: Inflation% year

Baseline

Forecast



0

2

4

6

8

10

12

14

16

2007 2009 2011 2013 2015 2017 2019 2021

China: GDP% year

Baseline



Forecast

-4

-2

0

2

4

6

8

10

2007 2009 2011 2013 2015 2017 2019 2021

China: CPI inflation% year

Baseline



Forecast

5

5.5

6

6.5

7

7.5

8

2007 2009 2011 2013 2015 2017 2019 2021

China: Exchange rateYuan/$

Baseline

Forecast



Depreciation

0

1

2

3

4

5

6

2007 2009 2011 2013 2015 2017 2019 2021

US: Policy rate%

Baseline

Forecast



Chart 6.7: Mexican GDP Chart 6.8: Mexican inflation

Chart 6.9: Chinese GDP Chart 6.10: Chinese inflation

Chart 6.11: Chinese exchange rate Chart 6.12: US policy rate

-8

-6

-4

-2

0

2

4

6

8

2007 2009 2011 2013 2015 2017 2019 2021

Mexico: GDP% year

Baseline

Forecast




54

0

500

1000

1500

2000

2500

3000

2007 2009 2011 2013 2015 2017 2019 2021

US: Equity prices


Baseline

Forecast



-8

-6

-4

-2

0

2

4

6

8

10

12

2007 2009 2011 2013 2015 2017 2019 2021


Germany

Forecast


Japan

US



Baseline

0

50

100

150

200

250

2007 2009 2011 2013 2015 2017 2019 2021


Baseline



Forecast

20

40

60

80

100

120

140

2007 2009 2011 2013 2015 2017 2019 2021



Baseline

Forecast


0

1

2

3

4

5

6

7

8

2007 2009 2011 2013 2015 2017 2019 2021

World: CPI% year


Baseline

Forecast


Chart 6.13: US bond yields Chart 6.14: US equity prices



0

1

2

3

4

5

6

2007 2009 2011 2013 2015 2017 2019 2021


Baseline



Forecast


55

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