Sentiment on the global economic outlook has darkened over the past couple of months, as the data flow has continued to disappoint. However, while underlying global growth continues to gradually deflate, we believe that fear is trumping reality and that the deterioration in fundamentals has not been as severe as what the decline in sentiment and financial markets has been.
There have been many reasons put forward for the deterioration in market sentiment, but we believe the primary factors have been the deterioration in the global growth outlook, as the trade war fears have remained elevated, geopolitical risks have failed to diminish (BREXIT) and leading economic indicators have weakened in both Europe and China.
However, while growth remains under pressure, we believe markets have over-reacted to negative news flow. It is true that growth surveys did weaken further in December, but there remains little evidence, at least at a global level, of a rapid slowdown.
Indeed, while there are clear areas of economic weakness, with Europe particularly soft (it is possible that Germany is in a technical recession) and concerns around China are still building, it is notable that global growth looks to have been a little better in Q4 than in Q3, with GDP likely to have expanded by a still above average 3% saar (3½% when weighted by PPP).
Our economics team make two further observations on the data flow:
First, and despite fears that growth has slowed through the quarter, the December manufacturing survey observations suggest that growth will only slow a little further in Q1;
Second, as is often the case, the services sectors in most economies have so far remained more resilient than manufacturing, with the global composite PMI having been broadly flat since September, at a level consistent with GDP growth entering the New Year at a pace similar to its long-run average.
Source: Bloomberg, MWM Research, January 2019
Nevertheless, we continue to think that 2019 will remain a most dangerous year with volatility likely to return before too long. Indeed, with global growth still under pressure, markets will remain hostage to several foreseeable but unforecastable events.
While the odds of a trade deal have brightened, if for no other reason than the importance President Trump places on the performance of the stock market, failure to seal a deal by the 1 March deadline would be a big negative for markets. A further increase in tariffs, given weakening global growth momentum, would have a significant impact on growth and sentiment.
Similarly, while most analysts still expect the UK parliament to ultimately pass Mrs May’s Brexit deal, we are sure to see many more twists and turns before the March 29 deadline, with the risk of a hard Brexit likely to keep markets on edge. While in our view markets have overreacted to the near-term risks, in part this probably reflects the emerging realisation that if a recession were to arrive, both fiscal and monetary policy would have far less room to respond than seen in previous cycles.
United States: Still a fortress
Our outlook remains for a modest slowdown in US growth, but to a pace that is likely to remain above potential. On a 4Q on 4Q basis, we are forecasting real GDP growth of 2.4% in 2019, down from 3.1% in 2018. We have also revised upwards our 2020 real GDP growth forecast to 2.1% (prev. 1.9%) reflecting fewer rate hikes in 2019, a stronger contribution from real consumer spending, and a potential recovery in energy capital expenditures.
Macquarie’s US economics team believes the outlook for continued strong real US GDP growth is supportive of further rate hikes. However, the recent financial tumult combined with global uncertainties means the Federal Reserve is likely to undertake a “pause” in 1H19. Doing so will help mitigate the risk that financial market fears of a more significant downturn become a self-fulfilling prophecy.
The likely moderation in inflation figures in 1H19 together with the headwind from energy capital expenditures help to reduce any urgency to hike rates further. However, this should not be construed as an overarching policy pivot, but rather a 6 to 9-month delay in the timing of hikes to allow for uncertainties related to recent financial tumult to clear. We continue to believe that the Fed will move to hike rates in 2H19. Macquarie’s updated base case is 2 hikes in 2019 (down from 3-4 hikes previously). We also now anticipate a further 1-2 hikes in 2020 (vs. 0 previously).
The key driver of our view remains the labour market. Monthly jobs growth over the last year (~220K) is more than triple the pace of underlying labour force growth (~70K). Even with our projected slowing, this pace is likely to remain healthily above what is needed to reduce the unemployment rate through 1H20. Moreover, later in 2019 and into 2020 inflationary pressures are likely to build, adding to domestically driven reasons to hike rates.
While weakness in the rest of the world is likely to remain a drag on the long end of the US yield curve, stronger wages growth and ultimately modestly higher US inflation should see bond yields move modestly higher again once the impact of the fall in oil prices washes through. We expect the 10-year yield to reach 3.25% by end 2019 and 3.50% by end 2020.
China: Gradual slowdown to continue but policy stimulus is building
Chinese growth has continued to slow as we enter 2019. However, while the market has once again begun to fear a more abrupt slowdown, so far the downdraft remains relatively gradual.
While the market was worried by the December dip in both the manufacturing PMIs to below 50, this does not point to a contraction in growth but rather correlates with a rate of around 6%.
Fears of China weakness have been amplified by an earnings downgrade from Apple and more recently Samsung, with some suggesting that sales weakness is reflective of a significant demand slowdown.
Macquarie believe that Chinese retail sales have been depressed by the fall in auto sales in recent months, with non-auto sales actually significantly stronger than the headlines suggest. In terms of Apple sales, while the deterioration shocked the market, we do not think it is representative of a generalised weakness in Chinese consumer demand. Rather it appears to reflect changes in the Chinese smartphone market.
Macquarie’s China economics team believes investors should not get too negative, as 2019 is not 2018. Policy makers took only four days to escalate recent policy stimulus after the PMI broke 50. However, the desire to avoid building on structural excesses will ensure that policy makers are unlikely to stimulate as they did in 2016. We continue to think that stimulus will stem the deterioration in sentiment although the path of a gradual growth deceleration will remain in place.
Europe: How close to recession?
After a strong 2017, Europe was the biggest disappointment in 2018, with the weak pace of growth likely to continue into 2019. The weakness in Q3 was in part due to the dip in activity in the auto sector as the car companies struggle to meet new emission standards. However, it is noticeable that despite a modest rebound in German auto production in October and November, German IP was very weak in the month of November. While it is possible to rationalise this weakness as yet another statistical quirk (this time because of a working-day effect), the ongoing weakness nonetheless increases the chance that Germany has a second successive fall in real GDP in Q4, an outturn that would have a large impact on already bruised market sentiment.
Another concern has been the impact on the French economy of the Gilets Jaune protest. This has seen PMI surveys plummet, and while these often overstate such events it seems likely growth will have slowed sharply in 4Q, an unfortunate development particularly since France had been one of the better performing Eurozone economies in 3Q.