A summary of our outlook for economies and markets.
4 minute read
Global growth slowed sharply over the course of 2018...
According to the IMF, global growth was estimated to be 3.7 per cent in 2018, a similar rate of increase to that seen in 2017.
When taken together, the past two years represent the strongest period of global growth since the start of the decade. However, the stability of calendar-year average growth masked a marked slowdown in sequential growth rates over the course of 2018.
Across the G20 group of economies (which account for around 85 per cent of global output), quarterly annualised growth slowed from around four per cent at the end of 2017 to just over three per cent by the end of 2018. That slowdown reflected a weakening in global manufacturing and trade, with the earlier policy-driven tightening in credit conditions in China resulting in weaker external demand across the major trading nations in Europe and Asia. Our own “nowcast” estimate of global growth suggests a further slowing in 2019Q1 (Figure 1).
Figure 1. Global growth cycle - Growth slowed through 2018
...key question for markets is when that slowdown comes to an end.
A key question for global risk markets, which have rallied sharply this year following the sell-off in 2018Q4, is whether global growth reaches a cyclical low-point in the early part of 2019 and then turns up again, or whether the recent downturn portends something more serious.
We expect a modest recovery in growth over the second half of 2019, leaving Calendar-year growth around trend.
Our latest analysis of the major economies suggests global growth will slow this year by somewhat more than we had previously expected (Figure 2), to around 3.4 per cent.
We have revised down growth expectations for the euro zone the most, but more generally have revised growth down across the major economies.
Figure 2. AI forecast revisions for major economies in 2019 - We have revised growth expectations down for 2019
The deeper slowdown largely reflects developments in advanced economies, with calendar-year growth in the United States and the euro zone expected to be around ¾ per cent lower in 2019, with particularly weak growth around the start of the year. Some of that reflects temporary factors, such as the impact of the government shutdown in the US and car production in Germany. But globally the impact of slower growth in China is expected to persist through to mid-2019. In the US, the fading boost from the fiscal expansion in 2018 also acts as somewhat of a drag on growth this year.
While we have revised down our growth expectations for 2019, we continue to see only a modest risk of recession this year in the major economies. Recessions tend to result from a set of imbalances (e.g. household or corporate balance sheets) becoming too stretched, central banks raising rates aggressively (e.g. to choke off inflation) and/or some sort of exogenous shock (e.g. oil prices). We think the risk from the first two of those remains contained. We also feel that the most serious exogenous risk to the global economy is an inability for the Chinese authorities to shore up growth there.
We expect continued modest upward pressure on wage growth and inflation.
While growth was above trend and rising in recent years, eroding spare capacity, wage growth was slow to respond. And although wage growth moved higher across the major developed economies in 2018, that did not pass through into higher inflation.
In the case of the US that might have been due to the improvement in productivity growth. Alternatively, it could just reflect a more limited pass-through than in the past due to a range of structural factors. We remain of the view that inflation will rise steadily so long as growth remains above potential and the unemployment rate is very low.
In our central scenario we expect the global growth cycle to extend beyond this year, supported by a pause in the global monetary tightening. If growth does pick up in the way we expect, then we would not expect central banks to be at the start of an easing cycle. Indeed, it may still be the case that the Federal Reserve will need to consider raising rates again towards the end of 2019 or early 2020. This will, however, be contingent on higher inflation and not just growth.
We think the Fed is on pause, rather than at the start of a cutting cycle this year. But that requires a recovery in global growth and moderately higher inflation.
Meanwhile the European Central Bank (ECB), which has yet to begin its rate hiking cycle, is now unlikely to begin that this year, but rather in 2020. However, if global growth does not stabilise and pick up over the course of this year, then the case for lower rates in the US would become stronger. If that were reflective of a global factor, then the scope for those central banks still at the effective lower bound, such as the ECB and Bank of Japan (BoJ), to ease further would be more constrained.
It is in this scenario that we may expect to see increased use of fiscal policy to help manage the next downturn. As this House View went to print, financial markets were pricing in three rate cuts by the Federal Reserve over the next two years, arguably placing a material probability of recession, or at the very least a more significant slowdown in growth (Figure 3).
Figure 3. Monetary policy re-set - Markets now expect rate cuts in the US
One reason that the Federal Reserve and other central banks may have changed their policy outlook so significantly over the last three months is the benign outlook for inflation.
With the Fed’s preferred measure of core inflation having been at or below two per cent for the past ten years, and the euro zone and Japan struggling to generate even that much inflation, central banks may try to manage policy in such a way as to generate a period of above-target inflation in order to ensure inflation expectations do not become de-anchored to the downside.
We prefer to be moderately overweight equities and credit, while being neutral on government bonds.
The sharp equity and credit market sell-off in 2018 Q4 has been quickly reversed at the start of 2019. That has come on the back of a pivot from the Federal Reserve and other central banks away from further rate hikes.
With the hurdle to another pivot in the near-term high, we expect the current central bank rhetoric to remain in place well into the second half of the year. As a result, we think there is a window of opportunity for risk assets to continue to perform well. As such, at this time we prefer to be overweight equities, with a tilt towards the US over other markets (Figure 4).
Figure 4. Asset allocation summary - Overweight equities, neutral Government bonds
We expect the environment to be positive for carry strategies as well, and therefore prefer to be overweight emerging market local and hard currency bonds. However, we think that the window could close for one of two reasons.
First, that the expected improvement in global growth does not come to pass (eg if the Chinese stimulus proves to be insufficient to raise growth there). Second, in coming to pass it could bring with it the realisation from central banks that policy is too accommodative, even while accepting a period of above-target inflation. At this time we think the balance of those risks is more heavily tilted to the former, and therefore prefer to be broadly neutral duration, an overweight in the US funded by underweights in Europe.