2019 set to be a tougher year…
Growth momentum has weakened in the second half of 2018, particularly in European and Asian exporters, who are responding to the end of above potential growth of the last few years, which has moderated final demand growth. Tariffs, restrictions and tighter financing costs have reinforced this trend, making final harder to forecast and encouraging caution on new investment decisions, Meanwhile Fed tightening, exit from quantitative tightening and boost in available US Treasurys, have begun to increase debt service costs across a range of sectors and geographies.
Slowing final demand growth globally is not a surprise, and has been a part of our themes for the last year, but the trade disputes and restrictions have reinforced some caution from buyers and supply chains. The drivers of this slowing of growth include a) the disconnect between policy stance in the U.S,. and other major economies across fiscal and monetary policy b) the lack of structural measures to boost final demand growth, c) removal of the “sugar rush” of monetary policy support as quantitative tightening takes hold. The U.S. and Chinese central banks have been particularly focused on continuing with business as usual, with overall policy stances only partly supportive. In both cases, a relative disconnect between fiscal and monetary policy complicates the messaging, and exacerbates some of the FX pressure.
China’s economy is slowing, mostly due to structural issues and the persistence of politically motivated deleveraging and centralization. Chinese authorities have loosened policy moderately since early 2018, but are unwilling to expand stimulus meaningfully, fearing the balance sheet impacts. The Chinese policy path remains critical to the global economy given its size, its commodity demand and the capital flow and currency trend. The Chinese government concern about excessive FX weakness reflects mostly balance sheet concerns including the importance of attracting capital to soak up debt issuance of local governments and corporates with political pressure in the region a lesser concern.
But perhaps not as tough as people fear…
Market repricing has been sharp, with U.S. equity markets now playing catch down to global market underperformance. Rather than solely signaling a weaker growth performance in 2019-20, much of the correction reflects a broader inability of companies to meet the excessively optimistic top-line earnings. The optimistic earnings reflected in part one-off benefits from the tax cuts introduced last year. The flattening and inversion of the U.S, yield curve remains a challenging indicator as global central banks continue to manipulate prices via their large holdings. This suggests that market actors may be excessively pessimistic about the pace of growth.
Across most major economies, economic activity continues to expand – near the “as good as it gets” marks, but the quality of growth is facing challenges, in part due to the impact of tariffs, and ineffective investment, The adjustment in 2019 is more likely to prompt another phase of downward adjustment in long-term growth.
U.S. China trade lacks an easy resolution: The trade sentiment rollercoaster has shifted more directly to the critical issue – Chinese policy rather than the (distracting) concerns in North America, Europe and other allies. The breadth of the U.S. concerns about Chinese economic, trade, investment and security challenges belies an easy resolution despite the desire for a deal at the highest level. President Trump, who sees himself as a “great dealmaker” wants to be able to announce a key deal that has avoided past administrations. This desire puts him at odds with many of his staff, and indeed much of congress, who remain concerned about what items would be part of this deal. As a result, even if a framework deal is announced at the G20 (60% chance), it is at best a “deal to have a deal” and timebuying, which could be positive for risk assets in the near-term but would not forestall new investments
U.S. Divided government likely to block macro policy changes and put more uncertainty in foreign policy, especially sanctions policy. The U.S. administration is likely to use more of its executive powers on trade (implying shallower deals which do not require congressional approvals), immigration, and foreign policy, Meanwhile, democrats in the House will likely to push to increase sanctions pressure on Russia and to a lesser extent Saudi Arabia, trying to lock the hands of the administration. In turn, these will add friction to business interests, and complicate some transatlantic ties. Investors focus on Russia likely still underestimate these risks. . Congress is likely to focus on domestic economic policies but is unlikely to have the votes to actually pass some additional measures on infrastructure or shifting the composition of trade. Efforts to switch expenditure are likely, but may not pass the Senate.
The oil price drop has seemed more credit negative than positive even for the U.S. which has become a net energy exporter, and more reliant on energy-linked investment and manufacturing. While the U.S, consumer will still benefit from lower oil prices, which will help offset the impact of other rising costs relating to trade tariffs, the sharp speed of the recent oil price decline, and its links to worries about fuel demand growth, suggest that there is as much damage as benefit at least in the short-term as markets over-correct in their pricing of corporate repayment risks. Current oil price trends are similar to projected market prices from early in 2018, but the volatility has made it difficult to take advantage – particularly in jurisdictions like Canada, which is suffering from a widening out of discount on its heavy crude (WCS), that is adding to some policy desperation.
Typical winners from a drip in the oil price include emerging market economies such as Turkey, which suffered sharp currency depreciation in the last year, as well as others like India and South Africa, which had more moderate pressure on their currencies. A lower oil price, should it persist, would be positive for their external balances, consumer purchasing power and in some cases fiscal positions. Overall, the broader impact on financing costs and credit crunch will likely restrict domestic demand further than any benefit from cheaper transportation.
Emerging Markets: Still divergent, but mostly weaker. These trends suggest a slowdown across a number of emerging markets, but this is a moderation not a cross the board recession. Relative outperformers remain in Eastern Europe, ASEAN and the pacific coast of Latin America, which have more policy space. Overall, Latin America, and the Middle East and Africa continue to have a challenging outlook, especially those with USD debt (not the majority). Its unlikely that Brazil will be able to quickly pass its pension fiscal measures, but the quick policy stance of Asian economies like India and Indonesia looks to be in a better position, to do some select easing.
What could make things better?
• More utilization of fiscal space outside of the U.S., especially by a range of developed economies including Canada while rates are still low. In Europe, the need is particularly great as repressed demand in the periphery is adding to net surpluses across the zone and leaving the region too reliant on external demand in the U.S, and to a lesser extent Asia. China too could focus its fiscal space on persistent social spending to reduce the reliance on short-terrm financial projects and better utilize national savings.
• Removal of some of the tariff threats via some sort of negotiated agreements (directed purchases of commodities and some additional IP safe guards). Removal of these risks might make it easier for businesses to plan and assess changing supply chains rather than be faced with short-term tax volatility.
• Better split between fiscal and monetary policy in the U.S. or better allocation of fiscal spending in the U.S. including a greater focus on infrastructure, which could actually increase potential growth while reducing some persistent barrriers to consumption and investment.