InvestmentsMar 27 2019

Facing up to prospect of a global slowdown

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Facing up to prospect of a global slowdown

Is the global economy headed for a slowdown, or something worse? That’s the question investors have been pondering over the past few months.

Signs that economic performance is beginning to dwindle have hurt stock markets around the globe since last October – but there are still plenty who think these fears will ultimately prove misguided.

For now, there looks to be compelling evidence that the headwinds are real, or at least that economies are failing to meet expectations. The economic surprise index produced by Citigroup, which measures whether individual pieces of global economic data have underperformed or outperformed forecasts, now sits at its lowest level since 2013.

While the UK remains mired in internal and external Brexit negotiations, other parts of the world economy have issues of their own. There are two particular problem points, and both relate, at least in part, to the US-China trade war. After signs of a recovery in 2017-18, Europe is slowing again, and the powerhouse of continental growth, Germany, is among those stuttering this time. Data released last month showed the country narrowly avoided slipping into recession in the fourth quarter of 2018. 

Many of Germany’s problems centre on manufacturing. Latest statistics show a surprise drop in industrial production in January, even as other indicators such as retail sales improved. A big driver of this slump is the trade war, which is affecting Asian demand for German exports.

Unsurprisingly, Asia itself has not escaped these pressures. Machine orders in Japan dropped 30 per cent year on year in February, while Korean exports fell 20 per cent year on year in March.

The focal point of all this is, of course, China. Having borne the brunt of the trade war fallout so far, the world’s second-largest economy is again slowing down – but perhaps for unrelated reasons. 

China’s dilemma

The continual debates over whether the country will experience a hard or soft ‘landing’ after years of healthy growth have either concluded in favour of the latter stance or simply become more complicated, depending on your viewpoint. 

Nonetheless, Beijing finds itself in a familiar position. Its dilemma is whether to prime the pumps again in order to boost growth, or whether to seek a more effective way of managing its switch from export-led growth to a consumer economy – a shift that has become more urgent in light of the protectionist policies emerging from the trade war. 

In the past, rapid stimulus has always been the answer – other major nations, which remember the boost enjoyed by the global economy from the previous round of Chinese policy easing in 2016-17, may be hoping for more of the same this year. And there are signs that the taps are being turned on: Chinese premier Li Keqiang, perceived as being more cautious than President Xi Jinping when it comes to stimulus measures, said on March 15 that the country would have to “take strong measures to face the downwards pressure”, according to media reports.

Francis Scotland, director of global macro research at Brandywine Global, says of the latest measures: “[Mr Li] made China’s recent policy pivot official...with the announcement of tax cuts and infrastructure spending alongside a reduced growth target for 2019. The recent slump in China’s economy has largely been self-inflicted: a byproduct of Beijing’s focus on deleveraging and muzzled shadow bank lending since 2017.

“A number of measures were implemented in 2018 to arrest the decline, none with much effect. Following what had to be a panicky meeting between Mr Xi and party bosses a few weeks ago, this announcement dials up the policy efforts to stabilise growth. The stock market is a believer, up almost 24 per cent this year after falling throughout 2018.”

The mood in the US

Things are a little calmer on the other side of the trade war. The US Federal Reserve has felt confident enough in the economy to hike interest rates several times over the past 24 months, and unemployment rates continue to fall. But there is nervousness here, too: the market jitters at the end of last year were sparked by the sense that the Fed may have tightened too much too soon, and sure enough it has now effectively paused its hiking cycle. 

There are also signs of renewed unease in the US housing market, and while companies focused on the domestic economy posted decent first-quarter results, those with international exposure have understandably been hurt by other economies’ struggles. 

The US recovery seen over the past decade has been steady but not spectacular. That stands in contrast to the fortunes of risk assets, which have raced away over the same period. Given the current bull market is already the longest on record – and economic expansion has continued for several years, albeit at underwhelming levels – the debate for many is not if a recession will arrive, but when.

Most economists believe it is highly unlikely that this kind of downturn will arrive this year, or even in early 2020. Adrien Pichoud, chief economist at Syz Asset Management, says of the latest US GDP figures: “[A] slowing growth trend was to be expected and is not necessarily linked to the more worrying growth softness experienced in Europe and China. 

“The US economy is gradually ‘coming back down to Earth’ after the growth spurt triggered by the Trump tax cuts of early 2018, with a split Congress now preventing the renewal of such fiscal stimulus.”

With the Fed on pause, that means the ‘goldilocks’ period for the world’s largest stock market – where economic activity is not too strong to warrant further tightening, but not too slow to spark real concern – can continue for a while longer.

Stagnant

But it’s not too great a leap from goldilocks to the concept of secular stagnation. This idea sums up a school of thought that suggests the post-financial crisis era is still not well understood by politicians. 

Secular stagnation theories say the “natural” rate of interest in advanced economies – the rate at which suitable savings and investment levels balance out within an economy – has fallen to a far lower level than many think. As a result, it simply is not possible to stimulate demand without a series of extraordinary monetary or fiscal policies, or huge levels of private sector borrowing.

Given quantitative easing’s emergence as the monetary policy of choice over the past decade, some may think these actions have been taken already. But there is one obvious counter-argument, suggesting such moves have been nowhere near effective enough for the regular economy. QE has inflated asset prices, but the absence of inflation elsewhere remains a point of particular concern for policymakers.

Earlier worries about ‘stagflation’ – low growth and persistently high inflation – are far removed from the reality of the current situation, where consumer price inflation remains conspicuous by its absence in most major economies. Many economists are again revising down their price growth expectations for 2019, as Table 1 shows.

Table 1: Global inflation consensus forecasts

 

Weighting

2018 (actual)

2019

2020

World

100

2.8

2.5

2.5

All advanced economies

61.4

2

1.6

1.8

US

26.5

2.4

1.9

2.2

Eurozone

17.2

1.7

1.4

1.5

Germany

5

1.8

1.7

1.7

UK

3.6

2.5

2

2.1

Japan

6.7

1

0.8

1.2

Emerging economies

38.6

4.1

3.8

3.5

Brics

25.3

2.6

2.2

2.8

China

16.7

2.1

2.2

2.2

Note: Year-on-year growth (%). Source: Schroders. Copyright: Money Management

US policymakers may be starting to ease their focus on financial stability in a renewed effort to encourage the inflation that is arguably needed if the global economic system is to motor along again. 

Fed officials have spoken in recent weeks about changing their inflation guidelines, effectively being more open to tolerating price growth above their 2 per cent target, in an effort to offset periods when inflation is lower.

Some say consideration of these kinds of measures suggests deflationary pressures remain at the fore, a phenomenon that would lend credence to the secular stagnation thesis.

A different kind of stagnation is also apparent on another front: at the time of writing, there was renewed hope of a breakthrough in US-China trade war talks. But as the UK is currently discovering itself, trade issues are complicated and would seem to lend themselves to a lengthy period of negotiation and discussion. Investors could find themselves waiting for resolutions to both Brexit and the trade war for a while yet. 

Other policymakers, meanwhile, are facing up to a renewed slowdown at a time when many of the usual policy levers have already been pulled. It all points to an uneasy – albeit perhaps not calamitous – period for the global economy.