Global Macro: Spreading slowdown from industry to services points to ongoing weak growth – Recent economic data confirm that the slowdown in the global economy will be more protracted, increasing the conviction we have in our below consensus growth forecasts. Global trade and industry look to remain weak over the next few months. We attribute the slowdown in trade and industry to the past tightening of monetary policy – led by the US and China – as well as a confidence shock related to the ongoing trade conflict, which has caused a slump in capital spending.
Neither of these factors looks set to reverse quickly. Although the Chinese authorities have been easing monetary and fiscal policy, it remains piecemeal, reflecting their longer-term goals of keeping overall leverage in check. At the same time, the Fed – focused on domestic economic conditions – has judged that there is a need for only modest insurance rate cuts. Meanwhile, uncertainty related to the trade conflict looks set to persist, with no comprehensive deal in sight, despite this week’s US-China talks (see below).
Recent data also suggest that the sharp downturn in trade and industrial production has started to spill-over into domestic demand and the services sector. In particular, service sector surveys in the US and eurozone saw significant falls in September, while there has been softening in labour markets in both cases as well. This process is likely to continue, leading to some slowdown in advanced economy consumer demand in the coming months.
What could cause a positive surprise? A major stepping up of monetary and fiscal stimulus and – in particular – an early and clear resolution of the trade conflict would provide a positive impetus. Policymakers will do more going forward (we expect further modest easing from the Fed, ECB and PBoC for instance), but up to now stimulus has been tentative and a more forceful reaction may take time to come through. It would probably be only triggered by a further marked deterioration in economic conditions.
The risk of recession has risen, though it is not yet our base scenario. Although likely to deteriorate, the labour market and overall household fundamentals remain positive. At the same time, the easing of monetary policy – though modest – should also feed through over time. Still, the risks are tilted to the downside. There is a risk of a more severe corporate retrenchment on the back of an ongoing, or even escalating, trade conflict. A correction in risky asset prices could tighten financial conditions in this context, given the combination of uncertainty, areas of excessive leverage (for instance in the US corporate sector) and low liquidity in credit markets.
Inflationary pressures remain subdued and too low inflation rather than too high inflation is generally the concern of central bankers. The cyclical slowdown in economic growth means that cost pressures are leading to margin compression rather than price rises, while cost pressures are (and should continue) to ease going forward as labour markets weaken. At the same time, there are structural downward pressures on inflation from globalisation, digitilisation and a fall in inflation expectations. (Nick Kounis)
US-China Trade War: Piecemeal deal possible, but the big picture remains grim – US and Chinese officials are due to restart trade negotiations this coming Thursday. The timing of the talks is crucial, coming just before the 15 October deadline for tariff rises on USD250bn of US imports from China (from 25% to 30%), and also ahead of the final tranche of 15% tariffs on up to USD175bn of consumer goods that had yet to take effect (due on 15 December). This creates some potential at least for a delay to the planned escalation in the tit-for-tat tariff war. However, the talks come against the backdrop of an ever more erratic Trump administration facing impeachment proceedings (even if those proceedings are highly unlikely to lead to the US president being removed), and ahead of the 2020 presidential elections which are set to take place amid a significant economic slowdown.
China has already ruled out including commitments to changing its industrial policy or government subsidies – a key US demand for a comprehensive deal – which leaves only a piecemeal deal as the best case scenario for this round of talks (and even this remains highly uncertain). This could for instance involve the Chinese agreeing to further increase some agricultural imports from the US in return for a ceasefire on the tariff front. One reason to expect such a partial deal is the growing evidence that both economies are slowing on the back of the trade/tech war, so the political calculus might have changed somewhat in Washington and Beijing (but seeing is believing).
While such a deal would be supportive of market sentiment, it would do little to change the macro scenario, with businesses likely having built in persistent uncertainty to trade policy into their baseline outlooks. As such, we expect the trade war to continue weighing on global trade and manufacturing, in turn keeping a lid on investment and growth below trend. Even in case of some kind of deal, we think that strategic tensions, particularly on the technology front, between the US and China will linger. (Bill Diviney & Arjen van Dijkhuizen)