Some of this weakness outside the US is due to trade tariffs – for example, China – some due to deteriorating financial conditions, such as in most emerging economies, and some due to adverse weather (Japan).
Our baseline forecast is that these specific issues will not significantly worsen. So how could some of today’s key issues play out?
First, let’s take debt concerns.
Household debt as a proportion of the size of the economy in the US is lower now than it was 10 years ago. The same is not true of corporate debt, implying that higher interest rates and bond yields are a problem waiting to happen for businesses.
What about US recession risk?
A US recession is more likely than not in late 2019, or early 2020, as the US Federal Reserve (Fed) attempts to tame the boom in order to minimise the bust. It is important to remember that central banks never try to eliminate economic cycles – this would be impossible – rather, they try to suppress them.
European growth is another key issue.
A range of issues hindered Europe in 2018, including Italy’s budget spat with the European Commission, a strong euro, and the European Central Bank’s plan to conclude quantitative easing and raise interest rates.
The first of these has already resolved itself – a compromise has been reached and the updated budget passed through the Italian parliament; the second (prior currency strength) cannot be a headwind forever; and, for the third, we believe that a bounce in European growth in 2019 is likely.
As labour markets strengthen across a whole host of countries, this is good news for wage growth, but could add to inflationary pressures ahead.
Together, this implies a move towards a more ‘stagflationary’ environment – slower growth with higher inflation.
Although this can be symptomatic of an economic cycle beginning to slow down, we do not believe we are yet in the end game.
Policymakers across the globe will lose none of their sway in 2019
China’s authorities have made concerted efforts to stimulate economic activity, though this has yet to produce tangible results.
Growth is still low by historical Chinese standards, but could become more robust as these government stimulus efforts (including tax cuts) work their way through the system.
However, additional tariffs or a full blown trade war would pose serious economic threats, and not just to China – other emerging markets, particularly in Asia, are a hostage to China’s fortune.