1ECONOMICS ● GLOBALQ4 2018The short vs the longA simple dynamic is playing out in the global economy right now: the US is booming, while mostof the rest of the world slows or even stagnates. The stresses caused by this divergence areplaying out uncomfortably in many emerging markets. A US Federal Reserve that is raisinginterest rates to prevent the US economy from overheating is constraining the policy options ofcountries where financial conditions are tightening and trade tensions intensifying.Whatever the short-term strains, however, the long-term picture is likely to be markedly different.Our new analysis (see page 17) suggests that emerging economies will be the big drivers of theglobal economy, given their superior long-term potential relative to demographically challengeddeveloped markets. The next year or so may see the US economy continue to outshine others butthe next decade or so should belong firmly to EM, particularly Asia. DecouplingIt is becoming a familiar tale: as with our last set of quarterly forecast revisions, the story this quarteris once again to revise up our US growth forecasts for 2018-2019 and to edge down our forecasts formuch of the rest of the world. Gasoline prices may be higher, the real Fed Fund’s rate has finallyturned positive for the first time in more than a decade and US-China trade tensions have heightenedyet again but the fiscal stimulus continues to provide a lift. Personal tax cuts, together with record-lowunemployment, have helped to raise US consumer confidence to an 18-year high and strong after- tax corporate profit growth means the outlook for investment spending has brightened further. Littlewonder then that the FOMC, which has already raised rates three times this year, is confidentlypredicting that it will continue to tighten policy at a similar rate in the coming year.The rest of the world is looking a little less stellar but nothing too worrying as yet. Europe has clearlyslowed from the highs of late 2017 and business confidence is still softening but growth remainsslightly above potential and it is a similar story in Japan. Only the likes of Argentina and South Africaare actually already in recession but much of the emerging world is slowing or set to slower further inthe coming months. Hence, while higher interest rates might make sense for the domestic USeconomy, with much of the rest of the world losing momentum, it’s not obvious that other countriesshould follow suit. And yet, as recent months have shown, the choice may not be entirely theirs. Impact of triple shocks still unfolding in EMWe set out our stall regarding the outlook for EM in Triple shock, 28 June 2018, and see littlereason to change the message contained in that report now: US tightening, higher oil prices andongoing trade frictions are all taking their taking their toll on the growth outlook. Some of thepressure on EM may have faded as the dollar has reversed some of its appreciation but,dragged down by higher rates, tighter lending standards and falling equities, EM financialconditions are still tightening. The fallout in the most-affected countries is only just starting to befelt and the relief may prove short-lived. Our FX strategists expect the dollar’s rise to resume,the oil price has recently been on the rise again, as we expected, and in the near term we see agrowing risk it could touch USD100/b. Moreover, the latest round of 10% tariffs on USD200bn ofSummaryThe US is diverging from therest of the worldThe longer-term picture stillfavours EMStrong US domestic demandwarrants more tightening……but not clear others shouldfollow suitEmerging markets are stillunder pressureECONOMICS ● GLOBALQ4 20182US imports from China (and 5-10% tariffs on USD60bn of China’s imports from the US) hasbeen delivered. Perhaps influenced by the November US mid-term elections, no meetings arecurrently scheduled that might avert a further increase from 10% to 25% at the start of 2019.The auto sector is not out of the woods yet either. This all points to another challenging year or so for emerging economies. China has alreadyannounced some fiscal easing since the US imposed the first set of China-specific tariffs and morecould follow. We still expect growth in parts of EM to show some improvement in the course of 2019but less so than previously. And the uncertainties over US policy, in terms of the impact on globalrates and exchange rates as well as global trading relationships, suggest there could be a risk ofsomething much worse. Current account deficit countries still look vulnerable and their domesticpolicy setting may be forced to respond further if they face a persistent reversal of capital inflows. Key forecasts% ____________GDP____________ ___________Inflation______________2018f___ ___2019f___ 2020f ___2018f___ ___2019f___ 2020f World 3.0 (3.0) 2.7 (2.8) 2.5 3.1 (3.0) 3.3 (2.9) 2.9 Developed2.3 (2.2) 1.9 (1.9) 1.4 2.1 (2.0) 1.8 (1.8) 1.9 Emerging4.6 (4.7) 4.6 (4.9) 4.7 3.9 (3.8) 4.3 (3.7) 3.7 US 3.0 (2.8) 2.5 (2.4) 1.8 2.5 (2.5) 2.1 (2.0) 2.2 China 6.6 (6.6) 6.6 (6.8) 6.5 2.4 (2.5) 2.4 (2.5) 2.3 Japan 0.9 (0.9) 0.9 (0.9) -0.2 0.9 (1.0) 0.8 (0.8) 1.1 India* 7.3 (7.3) 7.4 (7.6) 7.4 4.5 (5.1) 5.1 (4.5) 4.5 Eurozone 2.0 (2.0) 1.6 (1.7) 1.4 1.8 (1.7) 1.7 (1.7) 1.8 UK 1.3 (1.3) 1.5 (1.5) 1.5 2.5 (2.4) 2.0 (1.9) 1.8 Russia 1.8 (1.8) 1.5 (1.6) 2.0 2.8 (2.8) 5.1 (4.5) 4.1 Brazil 2.0 (2.5) 2.9 (3.6) 3.0 3.6 (3.4) 4.5 (3.9) 5.0 Note: *India data in fiscal year (2019 = April 2019 to March 2020) GDP aggregates use chain nominal GDP (USD) weights and Inflation aggregates calculated using GDP PPP (USD) weightsParenthesis show forecasts published in the Global Economics Quarterly Q3 2018 Source: HSBC forecastsThe US upgrade (see US Economic Outlook, 12 September 2018) has kept our global growthforecast for 2018 unchanged but it has not prevented the 2019 forecast from being shavedlower. We also, for the first time, publish our initial projections for 2020, which are for ongoingexpansion in the global economy but at a slower rate, raising the question of how much longerthe Fed can continue to raise rates. The Fed in 2020 There could well be some near-term upside surprises on inflation from the trade actions but themain drivers of our expected US slowdown in 2020 are that the fiscal stimulus starts to waneand tightening financial conditions start to have an impact.As we think it is unlikely that globaldemand pressures will be sufficiently strong to add to inflation, we expect the Fedafter afurther 75bps of tighteningto take an extended pause at some point in H2 2019, with a viewtowards rate cuts by the end of 2020. But the fact is, by 2020 the risks become more polarised. By the start of that year, the Fed willbe more than four years into its tightening cycle and we know how they typically end –recession. For the US we can envisage two additional scenarios apart from our central one. Thefirst is also an ongoing expansion scenario in 2020 and beyond – that of the FOMC itself, wheregrowth is driven by productivity rather than employment growth and the Fed’s assessment of theneutral rate gradually rises and it delivers on its projection of three Fed Funds rises in 2019 andone or two more in 2020-21. For the European Central Bank this would also be the preferredscenario, allowing the governing council to contemplate taking policy rates into positive territoryeven as the Bank of Japan continues to buy more bonds. Trade tensions showing nosigns of abatingOur 2020 forecasts point toslower global growthTrade tariffs could keepinflation higher in the near-termBy 2020, the Fed will be along way into its tightening cycle 3ECONOMICS ● GLOBALQ4 2018However, the current neutral rate is unobservable in real time, so the risk here is that the Fedoverestimates it and eventually tightens too much. Over-tightening would ultimately end in amore marked slowdown, if not necessarily a recession. However, much could depend on thefinancial market’s response if the Fed ta