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The global economy: Increased uncertainty, apprehension

12 September 2019 Nariman Behravesh, Ph.D.

We've seen both good and bad news this past month. First, the good: the US Federal Reserve (Fed) cut interest rates as expected, and enacted additional fiscal stimulus. China, which initiated modest fiscal and monetary stimulus earlier this year, is likely to provide additional stimulus. Meanwhile, the European Central Bank (ECB) has promised additional monetary easing. Other global central banks have also lowered interest rates. Now for the bad news: the trade war between China and the United States has taken a turn for the worse, with the Trump administration threatening to impose 10% tariffs on an additional USD300 billion of Chinese imports, and China retaliating by banning US agricultural imports and devaluing its currency. As it stands currently, the impact of these new actions will be adverse but small. However, if this conflict escalates, the risks of a recession will rise sharply. Our outlook for specific countries, regions, and market conditions follow

The United States: New fiscal stimulus from the Bipartisan Budget Act of 2019 will add to growth:

The US Congress passed, and the president signed, the Bipartisan Budget Act of 2019 (BBA19), lifting spending caps and suspending the debt ceiling. BBA19 will result in additional fiscal stimulus, adding to growth in 2020 and 2021. Full-year real GDP growth is projected at 2.3% in 2019, down from 2.9% in 2018 but still above the roughly 2.0% trend pace. There are a number of factors contributing to the slowdown in US growth, including decelerating global growth, and the impact of the recent tariffs.

Europe: Political developments and economic indicators suggest Europe is headed for stormy waters

The rising probability of a "no-deal" Brexit and the prospects of snap elections in Italy and the United Kingdom have worsened the risk environment for businesses. Our latest real GDP growth forecasts for 2019 and 2020 are around 1% for the eurozone and the UK, with growth in 2020 likely to be modestly weaker than in 2019 and at risk for more downward adjustments ahead—even if the ECB delivers additional monetary policy stimulus in the coming months, as seems increasingly likely. Among major eurozone member countries, Germany remains the most vulnerable to any further external demand disruptions because of its relatively high export-to-GDP ratio, although this is partly offset by above-average resilience in domestic demand - notably private consumption and construction - and leeway for fiscal stimulus due to large recent budget surpluses. The Italian economy also has a high export exposure, but ongoing political and fiscal tensions additionally hamper domestic demand.

Japan: Near-term upside surprises

Japan's second-quarter real GDP increase of 0.4% q/q (1.8% annualized) was stronger than expected, and in response, we have raised our 2019 GDP forecast from 0.7% to 1.1%. The planned October 2019 consumption tax increase will temporarily boost private consumption spending through the third quarter of 2019; however, the downside is significantly weaker demand for the subsequent 9-12 months, leading to a slower growth rate of 0.3% in 2020. The downside risks for Japan could be amplified in a currency war; given the safe-haven status of the Japanese yen, such a war would likely lead to its appreciation, which would damage growth even more.

China: More pain from tariffs

China's growth was slowing before the latest round of trade hostilities, and if the United States imposes 10% tariffs on another USD300 billion of US goods imports from China, IHS Markit estimates the direct impact would be a reduction in China's real GDP growth of about 0.2 percentage point in 2020 and 2021. However, we anticipate that China would partially offset the adverse impact of new tariffs with additional policy stimulus. The 5 August currency devaluation was relatively small and meant as a warning shot, as the Chinese government quickly assured global markets it was not the beginning of "competitive devaluation." Nevertheless, further devaluation could trigger financial instability.

Other large emerging markets: At the mercy of the United States and China

Before the start of the trade tensions, slowing growth in the developed world and changes in monetary policy - initially with a tightening bias, since reversed - affected commodity prices, exports, currencies, and interest rates. The trade war has intensified these trends by disrupting global supply chains, pushing down commodity prices, and pummeling exports. On the positive side, the Fed interest rate cut in July and expected ECB stimulus allow central banks in the emerging world to ease their monetary policies. China's devaluation, if contained, may also be good news, allowing emerging-market currencies to drift down without collapsing.

Commodity markets: Increasing apprehension about growth and currencies

We see the disappointing demand growth in commodities markets in the first half of 2019 continuing throughout 2019 and into 2020, as the China-US trade dispute continues to slow economic growth and commodity demand. In addition, markets are keeping a wary eye on currency markets, specifically the strength of the US dollar and the potential for a currency war. This has pushed down most commodity prices, with the exception of precious metals, in the past few weeks. Despite sluggish demand and an expected August average Brent price of USD59/barrel, IHS Markit projects oil prices to increase to USD66/barrel in the fourth quarter of 2019 and the first quarter of 2020. This rise is mainly due to the anticipated increase in refinery runs to make more low-sulfur distillate to meet International Maritime Organization (IMO) requirements taking effect on 1 January 2020. Given ample balances, we predict the average Brent price to edge down to USD64/barrel in 2020, compared with USD65/ barrel in 2019, as slower demand growth and increased production by several non-OPEC, non-US suppliers increases downward pressure on crude prices in the year ahead.

Monetary policy: The Fed's challenges are more manageable than those of the European Central Bank, Bank of England, and Bank of Japan

The travails of the Fed are well documented, though, relative to other developed economies, US growth is strong, the risk of a recession is still fairly low, and interest rates are still positive—unlike in the eurozone and Japan. If the Fed needed to restart asset purchases, given the breadth and depth of US capital markets, it has many more options than either the ECB or the Bank of Japan (BOJ), where the need for such purchases is more immediate. The tool kits of the ECB and BOJ are more limited. In the case of the Bank of England (BOE), its hands are tied by the massive uncertainty related to Brexit. In the end, this probably means a bigger burden on the Fed to keep US and global growth from collapsing.

Currency markets: Ironically, the trade war is strengthening the US dollar

In the last couple of years, the stars have been aligned for a stronger dollar— including faster growth and higher interest rates in the US economy compared with other key developed economies. The irony is that the trade war between China and the United States is making the dollar even stronger. To begin with, the safehaven status of US markets means that every time tensions rise, there is a flight to US dollar assets. Foreign ownership of US debt recently hit a record level. Second, by depressing China's exports to the United States, the trade war reduces the demand for the renminbi and exerts downward pressure on the currency. Finally, the trade war is having a very negative impact on global trade and growth in some of the world's most open economies, such as Germany (where growth has turned negative).

Earnings and stock markets: Among other things, markets are worried about a repeat of 2015 and 2016

The risks of policy mistakes are enormous, and markets remain quite nervous— evidenced by recent large swings in global equity indexes. The US-China spat is not the only source of market anxiety. Other worries include weakening growth outside the United States, mixed earnings reports, uncertainty about what the Fed will do next, an inverted yield curve, and political instability in Europe.

This article also appears on Sina Finance

Posted 12 September 2019 by Nariman Behravesh, Ph.D., Chief Economist, IHS Markit


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