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Global economic outlook - recency bias

Investors are fearful of a marked slowdown in 2019 global growth, or even the possibility of recession, with growth-sensitive risk assets below their peaks in the first half of 2018.

In our view, markets are placing too much weight on recent transitory weakness in industrial output in their assessment of the growth outlook and recession risk.

  

“We expect a pick-up in activity into the start of 2019 and for the global economy to expand at a rate of around 3.5%, consistent with solid corporate earnings and low default rates.”

 

The US economy will enter 2019 with impressive growth momentum and the positive stimulus of tax cuts and extra government spending should not wane until the latter half of next year.

Japanese growth in the third quarter of 2018 was hit by natural disasters, but household income is rising at a solid clip and investment is expected to pick-up – some of it induced by preparations for the 2020 Olympics.

Recent weakness in the eurozone reflects temporary factors – notably a sharp fall in German auto production due to new emissions tests – as well as the unwind of the strong boost to growth from net exports in the latter half of 2017. But with financial conditions accommodative and domestic demand growth underpinned by rising household incomes and investment, growth is expected to be around 1.6% in 2019.

China is the ‘delta’ for global growth, accounting for approximately 40% of (nominal) global growth since 2010. China’s economy is now as large as the eurozone and is the world’s second-largest exporter of goods and third-largest importer. It is the most important export market for Japan and Germany (beyond the rest of the eurozone), and the dominant consumer of commodities.

Beijing has recently placed ‘deleveraging’ on pause and policy is becoming growth-friendly in acknowledgement of the slowdown in economic activity and the risks from the ‘trade war’ with the US. Our current assessment is that policy easing will be sufficient to deliver 6%+ GDP growth in 2019 and avoid a ‘hard landing’.

 

GLOBAL GROWTH FORECAST TO BE ABOVE TREND

Source: International Monetary Fund (IMF); October 2018 Note: Shaded areas denote NBER-dated US recessions

 

The downside risks to our base-case of above-average global growth and solid corporate earnings are meaningful and centre on China and trade. Beijing faces a difficult balancing act of supporting growth without abandoning the strategic goal of deleveraging and managing an orderly depreciation of the renminbi against the backdrop of the Fed steadily hiking rates. Additional tariffs on Chinese goods are more likely than not and the imposition of tariffs and quotas on global auto imports into the US cannot be wholly discounted.

  • The change (delta) in global growth ex-US is dominated by swings in the Chinese economy
  • China growth peaked in mid-2017 as Beijing embarked on a deleveraging drive – but policies are now being eased, with a return to economic stimulus
  • China growth stabilisation / upturn will boost global growth and the ‘re-coupling’ with the US, but the trade war is a powerful headwind

 

 

Europe, as well as Asia, is vulnerable to intensification and broadening of trade tensions. Policy uncertainty, especially with respect to trade, may already be having an adverse impact on global growth by constraining investment spending.

 

POLICY UNCERTAINTY ON THE RISE

Source: Economic Policy Uncertainty Index, latest data as at November 2018

 

On the upside, a stronger US dollar transfers growth and corporate earnings from the US to the rest of the world.Moreover, if the US Treasury yield curve continues to flatten it will temper the tightening in global financial conditions implied by further Fed rate hikes. Global investment spending could surprise to the upside in light of corporate sector intentions to boost capex.

Economic outlook: In summary

Our baseline is for another year of strong real and nominal global growth in 2019 and that fears of ‘late cycle’ and recession risk are premature.

Nonetheless, we are past the peak in growth and corporate earnings unless productivity trends improve or there is additional policy stimulus.

Risks are tilted to the downside from a sharperthan- forecast slowdown in China and an escalation in trade conflicts.