Global slowdown begins to look more troublesome
The drop in global equities in October was remarkable for its extent, the frequency of consecutive negative days, and the synchronized decline in all the major markets.
The most likely fundamental trigger for the severity of the equity correction was an increase in investors’ perceptions of downside, or even recessionary, risks to the global economy. Dramatic talk about trade wars obviously exacerbated the drop in confidence, FT reported.
The flow of economic data suggested that there was, indeed, a decline in world activity during October. In fact, the global growth rate clearly peaked late in 2017, since when there has been a noticeable reversion to the mean.
The period of above-trend growth that was so powerful last year proved short lived, and now seems to have been mainly cyclical, rather than secular, in nature.
However, the slowdown will be met with important policy adjustments, notably in China. Furthermore, temporary downward shocks to growth in the eurozone (car emissions regulation) and Japan (natural disasters) will disappear.
The weakening profile for global activity is therefore likely to represent nothing worse than a ‘return to normal and, in the absence of new downward shocks, will not develop into a full blown global recession within a 12-24 month forecasting horizon.
Nevertheless, until changes in Chinese policy gain traction, and trade threats abate, markets may continue to worry about downside risks.
Latest nowcast results
According to the latest nowcasts, activity growth in the world economy has slowed from a peak of five percent a year ago to only three percent now, about 0.7 percent below trend. Much of this decline has occurred in the last couple of months.
Growth has declined almost everywhere. China has slowed from 7.4 percent a year ago to 5.3 percent now, the lowest growth rate since the serious downturn in 2015. The eurozone has also reported disappointing data throughout 2018, and the latest dip in October has taken growth down to only 1.1 percent. In contrast, the US has been a beacon of strong growth throughout the year, bucking the global pattern.
Prospects for 2019
The main change next year is likely to be in the geographical pattern of global activity.
US: Fiscal and monetary policy will be far less supportive next year than in 2018. The positive fiscal thrust will drop from a peak of 0.8 percent this year to zero at the end of next year, assuming no further measures to reduce taxes or raise infrastructure spending after the midterm elections.
Furthermore, financial conditions will be much less accommodative, in response to continued Fed tightening, lower equity prices and the stronger dollar. Jan Hatzius of Goldman Sachs reckons that financial conditions will subtract 0.75 percentage points from growth next year, after adding a similar amount this year.
The sharp turnround in these policy measures will probably take growth well below its two percent trend rate by end 2019.
This slowdown, however, is a healthy development, given the concerns about severe overheating in the labor market
The eurozone and UK: The outlook here is quite hard to judge. Growth has already slowed sharply in 2018, reflecting adverse weather and a waning of monetary policy support, compared to last year. There were tentative signs of improvement around midyear, but Germany has been severely knocked off course by the change in emissions regulation in the car industry, causing a large new setback in business surveys in October. Meanwhile, Italy has been dented by the budget crisis this autumn.
Nevertheless, business and consumer confidence remain fairly robust, and the labor market is strengthening. The ECB is confident that underlying growth remains firmly around trend, and that seems like a sensible estimate for next year.
The UK, however, has been growing well below trend and is very vulnerable to a Brexit shock next spring.
China: This is where the downside risks seem most severe. The Chinese nowcast dropped sharply in October, following many months when it was fairly solid in the face of deteriorating news commentary.
This weakening has coincided with an increase in trade threats from Washington, and the politburo has now admitted that the economy is being affected by ‘external forces’. They now seem ready to act more aggressively to boost private sector activity, following the moderate easing in monetary policy and the decline in the exchange rate around midyear.
The latest policy statements place less emphasis on deleveraging and more on boosting private infrastructure spending than earlier announcements, and this should show up in monetary and other activity data before year end.
However, the outlook for 2019 also depends on whether presidents Trump and Xi can move towards detente on trade policy, as hinted by their latest telephone discussions ahead of the G20 Summit this month.
A bad outcome on trade could knock more than a percentage point off Chinese growth next year, making it much harder for domestic policy to fill the gap.
Global economy: A significant slowdown in the US looks likely, but this should be offset by a rebound in the Eurozone, China and Japan after temporary hits to growth dissipate, and Chinese policy easing takes effect. Growth may be around trend in 2019, slightly higher than the latest nowcast.
The risk of an outright recession remains moderate, at least in the absence of self-feeding shocks in the financial markets.