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Last year witnessed a growing repudiation of this status quo, evident in the surprise outcome of the UK and Italian referenda, as well as US presidential election. As we begin 2017, these winds of change are gaining force. Central banks are acknowledging the often counterproductive impact of ultra-easy monetary policy and shifting attention to the eventual withdrawal of accommodation. At the same time, the recovery in commodity prices and recent firming in global growth is shifting the focus from deflation to reflation. The same could be said of the increasing focus on expansionary fiscal policy. While this change brings hope, it also carries risk. In the US, fiscal stimulus arrives eight years into an economic expansion that is already near full employment, increasing the danger of the economy overheating. Although the Federal Reserve could respond by hastening the pace of rate hikes, it might overdo it. Similarly, an overzealous negotiating stance on existing trade relationships or imposition of protectionist policies by the incoming US administration could staunch the flow of trade—an outcome that would be particularly damaging to emerging markets. And in Europe, a victory of the far right in the French presidential election could unleash fears about France exiting the European Union and endanger the survival of the euro. Still, we do not yet accord a high enough probability to these risks to alter our base case, which assumes these winds of change fill the sails of the ongoing global recovery, rather than capsize it (see Exhibit 29). Exhibit 29: ISG Outlook for Developed Economies Exhibit 30: Duration of Post-WWII Expansions This expansion is already the fourth-longest since WWII. Recovery Duration (Quarters) 45 40 40 35 31 30 30 5 26 ™ 19 i 32 10 8 oO Mar-91 Feb-61 Nov-82 Jun-09 Nov-01 Mar-75 May-54 Nov-70 Apr-58 Jul-80 Business Cycle Trough Data as of December 2016. Note: The recovery is measured from the business cycle trough. Source: Investment Strategy Group, National Bureau of Economic Research. United States: Age Is Just a Number The US economic expansion is getting old by historical standards. At nearly eight years, it is already the fourth-longest in post-WWII history and poised to be among the top three by the middle of this year (see Exhibit 30). Concern that the economy’s vigor is finally succumbing to its advanced age was only bolstered by anemic 1.6% real GDP growth in 2016, close to the weakest of any year during the recovery. But as we have argued in the past and as Federal Reserve Chair Janet Yellen recently noted, “it’s a myth that expansions die of old age.” Instead, business cycles are typically derailed by United States Eurozone United Kingdom Japan 2016 2017 Forecast 2016 2017 Forecast 2016 2017 Forecast 2016 2017 Forecast Real GDP Growth* Annual Average 1.60% 1.90-2.70% 1.60% 1.20-1.90% 2.10% 0.50-1.50% 1.00% 0.75—-1.50% Policy Rate** End of Year 0.75% 1.25-1.50% 0.00% (0.50}(0.30}% 0.25% 0.00—0.50% -0.10% -0.10% 10-Year Bond Yield*** End of Year 2.44% 2.50—3.00% 0.21% 0.50-1.00% 1.24% 1.50-2.25% 0.05% 0.00% Headline Inflation**** Annual Average 1.70% 1.80-2.60% 0.60% 0.80-1.60% 1.20% 2.00-3.00% 0.50% = Core Inflation**** Annual Average 2.10% 1.80-2.60% 0.80% 0.90-1.40% 1.40% 1.50-2.00% -0.40% 0.25-1.0% Data as of December 31, 2016. Note: The above forecasts have been generated by ISG for informational purposes as of the date of this publication. They are based on ISG’s proprietary macroeconomic framework, and there can be no assurance the forecasts will be achieved. Source: Investment Strategy Group, Goldman Sachs Global Investment Research, Bloomberg. * 2016 real GDP is based on Goldman Sachs Global Investment Research estimates of year-over-year growth for the full year. ** The US policy rate refers to the top of the Federal Reserve's target range. The Japan policy rate refers to the BOJ deposit rate. ** For Eurozone bond yield, we show the 10-year German bund yield. **** For 2016 CPI readings, we show the latest year-over-year CPI inflation rate (November). Japan core inflation excludes fresh food, but includes energy. 38 | Goldman Sachs | JANUARY 2017 HOUSE_OVERSIGHT_014571