GLOBAL GROWTH SLOWED through most of 2018. But the pace of slowing accelerated meaningfully from mid-2018 into the first quarter of 2019. ‘Recession indicators’ started rising in the US, and growth concerns in Europe and China were reinforced by an escalation in trade tensions and ongoing deterioration in an increasingly wide set of economic data. Uncertainty about the future interconnectivity of the global economy will undoubtedly play a bigger long-term role in the global growth moderation than the direct impact of trade weakness, but the current situation has undeniably been exacerbated by idiosyncratic issues in several key economies, which should ease. The longer-term cost of heightened uncertainty is still to be counted.
Within this context, it is instructive to try to identify the sources of economic weakness and uncertainty, and then assess how durable the effects may be. These seem to fall broadly into three buckets:
1. CHINESE ECONOMIC ACTIVITY
The internal, policy-driven moderation in Chinese economic activity started in 2017. Successive stimulus interventions have seen an unprecedented accumulation of debt relative to GDP in China, which peaked at an estimated 250% of GDP in mid-2017. Reasonable concerns about the sustainability of both the stock and the rate at which it has increased prompted policymakers to moderate credit availability from the end of 2016. The impact of credit withdrawal led to a moderation in growth momentum, which affected domestic activity and then rippled into global trade.
2. US-SINO TRADE TENSION
The above factors coincided with the escalation of US-Sino trade tension, which saw the US initially impose 10% tariffs on $200 billion of Chinese imports in mid-September, followed by retaliatory tariffs from China on $60 billion of US imports. While the US and China’s negotiations are still ongoing, global trade indicators remain weak. The knock-on has started to affect global manufacturing and, more broadly, sentiment and business investment. The hardest hit have been large trading economies, including Germany, much of Asia and Japan.
3. INDIVIDUAL MARKET EVENTS
More randomly, there are a number of idiosyncratic events which have either materially exacerbated the impact of the above, such as the change in emissions regulations in Germany, or had the effect of weakening broader sentiment and hard data, such as a combination of US market volatility, the polar vortex and the shutdown of the Federal government in February. Elsewhere, political tension in France and the chaotic Brexit negotiations have negatively affected confidence and biased growth weaker.
For all this weakness, the resilience of domestic demand in these economies has provided a relatively robust buffer. Across a broadbase of developed and some emerging markets, the current economic cycle has seen unemployment fall to multi-decade lows. While there are ongoing questions about the quality of this employment growth, low levels of unemployment support wage growth – and we have seen earnings pick up in the US, UK, Japan and parts of Europe, to the extent that developed markets’ income growth now rivals the last expansion. This has not been enough to mitigate all the headwinds, but it is an important source of stability.
Despite all the bad news, at the time of writing, there is mounting evidence that the first quarter of 2019 may be the low point of global growth. Several ‘nowcast’ models (UBS and JP Morgan), which track changes in high-frequency data to monitor the state of the economy in real time, are pointing to an improvement in global growth momentum. While the activity data are still mixed, there is enough evidence to suggest that, at the minimum, disruptions in the US and parts of Europe are normalising, and policy intervention is gaining traction in China.
This base is narrow because global trade-related activity and associated indicators are still uniformly weak. Data published by Morgan Stanley suggest that global trade volumes slowed to just 0.5% year on year in March, from 1.0% in February, based on export expectations in the IFO Institute for Economic Research survey and hard export volume data from Korea captured by their trade indicator. For better certainty of a recovery in global growth, we need a few things to go ‘right’:
Firstly, China’s outlook is critical to the prospects and magnitude of a global recovery, given its significant contribution to the global demand weakness over the past six to nine months. The main drag on growth remains property construction and manufacturing capex. This should be countered by an improvement in consumer spending and the support from fiscal stimulus. The rise in China’s Purchasing Managers’ Index new orders for the second consecutive month is encouraging.
Secondly, some resolution to the US-Sino trade tension is needed in the form of an agreement on terms and implementation between the US and China. Not only is this key to an improvement in trade volumes; a better framework for dispute resolution is also a necessary condition to avoid a repeat of the past year’s standoff or a deterioration to something more hostile. The likelihood of achieving a robust agreement with long-term solutions is questionable given the US and China’s very different economic policies, but a stabilisation in tariff uncertainty should support confidence lost in the current state of flux.
Then, we need to continue to see the influence of the ‘one-offs’fade, especially the disruptions to US activity and spending after February, and the lesser influence of the manufacturing disruptions in Germany. The US Federal Reserve’s commitment to ‘patience’ should also provide a meaningful fillip by keeping global financial conditions easy for a prolonged period, although better growth could also see an uptick in inflation and ultimately put pressure on the Federal Open Market Committee to continue raising rates. Similar very dovish guidance from the European Central Bank suggests it will take a considerable change to conditions to alter its outlook, and we assume monetary policy will stay accommodative in coming months, even as activity picks up again.
Lastly, the ‘red flags’ raisedduring this period of slowing growth need to be tested. Not all the decline in growth momentum that we have seen in the past two quarters can be fully explained by the events listed above and, in some cases, these have not been resolved.
In China, we assume that much of the slowdown started with tighter credit conditions, which have started to ease modestly, and that fiscal interventions will buoy activity in the second half of 2019. It is possible, however, that the impact of credit withdrawal has not yet fully played out, notably on the property market, and that we have yet to feel the full impact of the trade war with the US. Both factors are considerable uncertainties, and hard to quantify.
For the US, the combined sluggishness in the housing market – which is at odds with the very supportive macro factors, including employment and wage growth, household formation and very supportive financing conditions – and emerging weakness in business investment are traditional signs of cyclical weakness, which are important to monitor.
In Europe, the impact of protracted weakness in the external sector may have a much deeper effect on growth. Global trade is a much stronger driver of internal growth momentum than in the US or China. Political uncertainty will play in the background and is not limited to Brexit. It also includes the outcome of the European Parliamentary elections, taking into account more populist and less traditional leadership in several member countries, as well as the impact of weak growth on Italian fiscal metrics, especially under the coalition government.
The umbrella risk is that the uncertainty imposed by all these factors becomes reinforcing in a global economy that is weaker and more fragile than it was at the start of 2018. Our base case, however, is that one-offs correct – and a few things go right – aided by strong domestic demand conditions in key economies and very supportive monetary policies.
We expect global growth to slow to about 3.4%, from 3.8% in 2018, and to recover to 3.7% in 2020. Within this, growth from emerging markets should be supported by recovering economies hard hit in 2018, including Argentina and Turkey, with emerging market aggregate growth expected to be 4.7% in 2019 from 5.0% in 2018, and 5.1% by 2021. Developed economies are more likely to remain under pressure, with the growth forecast flat at 1.8% in 2019 and 2020 as momentum from 2018 is lost and the US tax boost fades.