Global slowdown begins to look more troublesome
October’s collapse in equities may reflect weaker global growth
Gavyn Davies
© AFP
The drop in global equities in October was remarkable for its extent, the frequency of consecutive negative days, and the synchronised decline in all the major markets. The most likely fundamental trigger for the severity of the equity correction was an increase in investors’ perceptions of downside, or even recessionary, risks to the global economy. Dramatic talk about trade wars obviously exacerbated the drop in confidence.
The flow of economic data (see the latest “nowcasts” in the box below) suggests that there was, indeed, a decline in world activity during October. In fact, the global growth rate clearly peaked late in 2017, since when there has been a noticeable reversion to the mean. The period of above-trend growth that was so powerful last year proved short lived, and now seems to have been mainly cyclical, rather than secular, in nature.
However, the slowdown will be met with important policy adjustments, notably in China. Furthermore, temporary downward shocks to growth in the Eurozone (car emissions regulation) and Japan (natural disasters) will disappear. The weakening profile for global activity is therefore likely to represent nothing worse than a “return to normal” and, in the absence of new downward shocks, will not develop into a full blown global recession within a 12-24 month forecasting horizon.
Nevertheless, until changes in Chinese policy gain traction, and trade threats abate, markets may continue to worry about downside risks.
Latest nowcast results
According to the latest nowcasts, activity growth in the world economy has slowed from a peak of 5 per cent a year ago to only 3 per cent now, about 0.7 per cent below trend. Much of this decline has occurred in the last couple of months.
Growth has declined almost everywhere. China has slowed from 7.4 per cent a year ago to 5.3 per cent now, the lowest growth rate since the serious downturn in 2015. The Eurozone has also reported disappointing data throughout 2018, and the latest dip in October has taken growth down to only 1.1 per cent. In contrast, the US has been a beacon of strong growth throughout the year, bucking the global pattern.
Prospects for 2019
The main change next year is likely to be in the geographical pattern of global activity.
US: Fiscal and monetary policy will be far less supportive next year than in 2018. The positive fiscal thrust will drop from a peak of 0.8 per cent this year to zero at the end of next year, assuming no further measures to reduce taxes or raise infrastructure spending after the mid term elections.
Furthermore, financial conditions will be much less accommodative, in response to continued Fed tightening, lower equity prices and the stronger dollar. Jan Hatzius of Goldman Sachs reckons that financial conditions will subtract 0.75 percentage points from growth next year, after adding a similar amount this year.
The sharp turnround in these policy measures will probably take growth well below its 2 per cent trend rate by end 2019. This slowdown, however, is a healthy development, given the concerns about severe overheating in the labour market.
The Eurozone and UK: The outlook here is quite hard to judge. Growth has already slowed sharply in 2018, reflecting adverse weather and a waning of monetary policy support, compared to last year. There were tentative signs of improvement around mid year, but Germany has been severely knocked off course by the change in emissions regulation in the car industry, causing a large new setback in business surveys in October. Meanwhile, Italy has been dented by the budget crisis this autumn.
Nevertheless, business and consumer confidence remain fairly robust, and the labour market is strengthening. The ECB is confident that underlying growth remains firmly around trend, and that seems like a sensible estimate for next year.
The UK, however, has been growing well below trend and is very vulnerable to a Brexit shock next spring.
China: This is where the downside risks seem most severe. The Chinese nowcast dropped sharply in October, following many months when it was fairly solid in the face of deteriorating news commentary.
This weakening has coincided with an increase in trade threats from Washington, and the politburo has now admitted that the economy is being affected by “external forces”. They now seem ready to act more aggressively to boost private sector activity, following the moderate easing in monetary policy and the decline in the exchange rate around mid year.
The latest policy statements place less emphasis on deleveraging and more on boosting private infrastructure spending than earlier announcements, and this should show up in monetary and other activity data before year end. However, the outlook for 2019 also depends on whether Presidents Trump and Xi can move towards detente on trade policy, as hinted by their latest telephone discussions ahead of the G20 Summit this month.
A bad outcome on trade could knock more than a percentage point off Chinese growth next year, making it much harder for domestic policy to fill the gap.
The Global Economy: A significant slowdown in the US looks likely, but this should be offset by a rebound in the Eurozone, China and Japan after temporary hits to growth dissipate, and Chinese policy easing takes effect. Growth may be around trend in 2019, slightly higher than the latest nowcast.
The risk of an outright recession remains moderate, at least in the absence of self-feeding shocks in the financial markets.
The global economy in four key graphs
The latest monthly report on global economic activity from the Fulcrum nowcast models is attached here.
Main points:
1. The global economy has slowed noticeably in the last couple of months.
2. The main cause is a drop in Chinese activity . . .
3. The US economy remains very robust and continues to grow 1 per cent above trend.
Meanwhile, the rest of the world has now slowed to 1.3 per cent below trend . . .
4. Consensus economic forecasts expect global GDP growth to be slightly lower in 2019 than this year.
Downside risks may be building at present and consensus forecasts have been moving slightly lower . . .
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