The Global Economy - Poised To Slow In 2019

The IMF seems to be understating the risks that confront the global economy. According to their World Economic Outlook, October 2018, the global economy is projected to grow at 3.7% in 2018 and 2019. Considering the plethora of downside risks (stated below) looming over the global economy, I believe that global economic growth will be lower in 2019, relative to 2018. I am rather concerned about the 2019 economic outlook of major economies such as China, US, Germany, Japan and the UK, and highly export reliant economies of Asia (Singapore, Hong Kong, South Korea and Taiwan). 

As a harbinger of slower growth next year, the global economy witnessed moderation in momentum in 2018Q3 (along with lower trade volumes) - with China slowing more than expected, Eurozone growth slumping to a four-year low (although, some temporary factors contributed to the marked slowdown in growth), Germany (amid political uncertainty) and Japan witnessing economic contraction (with slowdown in exports contributing significantly to economic downturn in both economies), stimulus powered US economy (underpinned by a $1.5 trillion tax cut and increase in government spending) growing above trend (driven by strong consumer spending and government expenditure in this quarter), yet at a lower rate than in 2018Q2  - along with slowing business investment - and emerging economies as a whole on a weakening growth path. All this is a reflection of confidence being undermined globally, due to the simmering trade dispute between US and China and the accompanying uncertainty. 

Further, latest economic data from both major developed (including the UK economy too - where business investment has decelerated significantly) and emerging economies seems to suggest that the global economy continues to lose momentum in 2018Q4. Worryingly, the Chinese economy, which accounts for around 15-16% of global GDP and whose growth prospects matter significantly for emerging markets, seems to be witnessing substantial downward pressure - even though fixed asset investment and industrial production growth figures for October reflect tentative signs of stabilization and that the government’s stimulus is finally transmitting through to the real economy and preventing growth from slowing sharply.  

Plethora of Downside Risks

First, while results of the US mid-term elections substantially reduces the risk of another fiscal stimulus and faster than expected rate hikes by the Federal Reserve, I do expect a further escalating of the US-China trade dispute in 2019 (which is likely to endure at least until 2020), rising trade protectionism in the US (and globally) and belligerence by Trump on trade and foreign policy issues with other large economies too - such as the Eurozone and Japan (and possibly with Saudi Arabia too, as it plans to cut oil production). This is because the US Presidential elections will be held in November 2020 and Trump has a voter base which he has to pander too. All this is likely to undermine confidence, business investment, global trade and growth next year and result in more geo-political tensions that will probably unnerve global financial markets - engendering more volatility in equity, bond and currency markets globally.

Second, for reasons stated later in this article, I expect Chinese economic growth to falter over the next several quarters and project growth of around 6% in 2019 - even though moderate policy stimulus is likely to partially soften the downside impact of US tariffs on growth (China seems to be on track to meet its official growth target of around 6.5% in 2018). This in turn may significantly dent Asian economy exports to China in 2019. 

Third, with impending rate hikes in the US - along with gradual trimming of Federal Reserve’s balance sheet - further tightening of financial conditions, probability of fall in equity prices in the US and globally (and more volatility) and slowing housing market in 2019, the US, Eurozone and UK might witnesses gradual reduction of the substantial ‘wealth effect’ on consumer spending in these economies - particularly towards the latter half of 2019 - which in turn is likely to gradually undermine consumer confidence (despite tighter labour markets) and result in slower growth in these economies in 2019, relative to 2018. As a consequence, emerging economies’ (EM’s) exports to these economies will probably witness slower growth over the next year - at a time when rising trade protectionism, slowing Chinese growth and probable intensification of US-China trade dispute will, in all likelihood, result in lower demand for EM exports.

Fourth, prospects of a disorderly Brexit, US sanctions agains Iran’s oil exports, inability of US shale industry to dampen oil prices shocks, volatile oil prices outlook (oil prices should probably range between US$70-80 per barrel in 2019, considering supply-demand dynamics, US oil inventories, shale oil dynamics and possible reduction in OPEC oil supplies), Italy’s current growth-debt-political dynamics and its collision course with the European Commission over budgetary issues (Italy is targeting a fiscal deficit of 2.4% of GDP in 2019), recent electoral outcomes in Germany that are likely to result in continued divergence between France and them on reforms related to European macroeconomic governance framework and fragmentation pressures (that is likely to impede policy developments and structural reforms across the euro area) are all looming over the global economy - with downside implications for growth next year.

Fifth, global central banks gradually withdrawing easy monetary policy (which is likely to result in higher borrowing costs for firms and consumers in both developed and emerging economies over the next year), possibility of further rise in long term bond yields (the yield on benchmark 10-year US treasury bond has already crossed 3%) - due to higher rates and Federal Reserve’s ongoing balance sheet normalization - lower global liquidity, strong US dollar (puts EM’s under pressure), weakness of the Chinese currency - yuan (which is currently hovering very near the psychological level of 7 yuan per US$), strong probability of continuation of depreciation pressure on several emerging market currencies (ranging from the INR and yuan to Brazilian real, Russian rouble, Indonesian Rupaih, Turkish Lira, Korean Won, Argentinian and Mexican peso among others), presence of high levels of dollar-denominated debt worldwide, particularly in several emerging economies (which could result in higher corporate stress and defaults and potentially destabilizing capital outflows in some of these economies), threat of serious disruption to Asia-centred global supply chains and fragility of financial market sentiments are all important factors that are likely to have downside implications for global growth next year.

US Economy - growth momentum expected to slow in the latter half of 2019

Turning to the US economy, economic growth continues to be strong, labour market is displaying persistent strength - with 250,000 jobs being added in October, unemployment at only 3.7% and wage growth accelerated to a nine-year high of 3.1% year-on-year in the same month, from 2.8% in September (the tightening labor market is finally leading firms to raise wages, along with underlying trends pointing towards a pick up in wage growth) - and consumer confidence, driven largely by a robust labour market, and business sentiment remain robust. As a result, I expect the Federal Reserve to raise its policy rate in December 2018. 

Having stated the above, two developments point to the possibility of business investment slowing down in 2019 (particularly towards the latter half of 2019): first, business investment slowed markedly in 2018Q3 - which seems to indicate that the corporate tax cuts in the US have not had much effect on investment decisions of corporate America and uncertainty regarding outlook on tariffs is weighing on business decisions; and, second, the New Orders Index of the ISM Manufacturing PMI declined markedly in October.

Turning to future growth prospects,  I expect the US economy to grow above potential for around three quarters (i.e. around until 2019Q2) - supported by solid consumer spending, ramping up of government spending and moderate business investment spending.

Thereafter, I expect growth momentum to slow down in the latter half of 2019 - due to the fading away of fiscal stimulus, impact of tighter monetary policy beginning to take hold (I expect the Federal Reserve to raise its key policy rate in December 2018 and thrice in 2019), slowing business investment (as a result of higher interest rates, import tariffs, increasing manufacturing costs, higher wage costs, on-going US-China trade dispute, more uncertain and volatile economic outlook and weaker export outlook), tightening of financial conditions (which will be reflected in elevated long term bond yields and higher lending rates), weakening housing market (as higher mortgage rates, which have currently risen to a seven year high, are likely to increasingly moderate household demand for homes), possible correction in US and global equity markets - I expect the S&P 500 to witness a significant correction next year - slower US earnings growth for S&P 500 companies (which have recently been witnessing strong earnings growth thanks to sweeping corporate tax cuts) and trade tariffs (via its upside impact on prices of consumer goods) starting to have a noticeable downside impact on consumer demand. 

I expect the US economy to grow by just under 3% this year and around 2.5% in 2019. 

Chinese Economy - facing considerable downward pressure, despite policy stimulus

Going forward from 2018Q3, the Chinese economy seems to be slowing further in 2018Q4 - as reflected by a marked slowdown in credit growth (with notable fall in corporate loans and lower household loans) and money supply in October, weaker retail sales (growth slowed to a five month low in October - reflecting weaker consumer sentiment), official manufacturing PMI slowing to a two year low of 50.2 in October and services sector activity decelerating too - though activity levels yet remain healthy, fall in automobile sales and slowing housing market (residential investment growth and property sales decelerated in October). 

Further, the Chinese economy is facing downward pressure from continued decline in its stock markets (undermining confidence), regulatory restraint on riskier lending and rising uncertainty over prospects of domestic demand - which is hampering investment, record high corporate bond defaults, industrial overcapacity, marked rise in household debt, mounting local government debt (USD 2.58 trillion by the end of August 2018 - Ministry of Finance data - according to state-run Xinhua news agency), fall in forex reserves (which fell to a 18-month low of US$ 3.053 trillion in October - according to PBOC data) and marked plunge in the yuan against the USD this year - due to simmering US-China trade related dispute, concerns about China’s slowing growth, PBOC reducing its reserve-ratio for the fourth time in 2018 and the yield spread between Chinese and US government bonds.

Turning to 2019, I expect the Chinese economy to grow by around 6% in 2019, from the officially targeted 6.5% in 2018, due to substantial downward pressure on the Chinese economy from the factors mentioned above, a slowing property market and the US having already imposed tariffs on US$250 billion worth of Chinese imports, which came into effect in September, and possibility of more tariffs that will take effect from January 2019 along with rising trade protectionism  - which will to act a serious drag on Chinese exports over 2019.  

Though China will witness flagging growth over 2019, however, I still expect growth to be around the aforesaid forecast, as Chinese policy makers are likely to support growth via moderate and broad-based fiscal stimulus (which will increase China’s budget deficit in 2019) - comprising of tax cuts (such as lowering of corporate and value added tax rates), infrastructure spending on railways, highways and airports and bigger tax breaks for exporters - stepping up of funding support for private firms and smaller businesses, shifting to a looser monetary policy (i.e. possible reduction in benchmark interest rates or reserve-ratio requirements) and the central bank will possibly guide bond yields lower in 2019. Policy makers would find it rather difficult to undertake strong policy stimulus measures, given the huge build up of debt (exceeding 250% of GDP, as per BIS data) in the Chinese economy and attendant financial risks.

Eurozone Economy - growth likely to decelerate over 2019

Next, regarding the Eurozone, the economic outlook is deteriorating. This economy lost traction in 2018Q3 - where growth slumped to a four-year low. Further, as an indication that moderation in growth is now becoming more broad-based in the Eurozone in 2018Q4, global trade tensions  are having broader repercussions and that slowing growth could be prolonged over the next several quarters, manufacturing and services activity slowed in October - the IHS Markit Eurozone Composite PMI fell to 53.1 in October, from 54.1 in September (which is the lowest level in two years). Further, the Economic Sentiment Indicator (ESI) fell (for the tenth consecutive month) to 109.8 in October, from 110.9 in September (according to European Commission data) - the lowest reading since May 2017. Except for consumer confidence, all other sectors (industry, services, retail trade (in particular) and construction) witnessed waning of confidence in October. 

Regarding 2019, the Eurozone is likely to grow at a slower rate in 2019, relative to 2018, due to Brexit related uncertainty, slower export growth (given possible decelerating growth in emerging markets), strong possibility of US economic growth slowing in the second half of 2019, lower business investment (due to possible intensification of US-China trade dispute and decelerating export growth), significant downward pressures on the German economy (due to the US-China trade dispute posing significant risks to its supply chains, vehicle sales and manufacturing exports and possibility of no-deal Brexit that can hit its exports hard), political uncertainty in Germany, Italian and European Commission standoffs, increased risk aversion, higher borrowing costs and rising trade protectionism, which will further dent business confidence.

UK Economy - a protracted slowdown or even a recession is possible

With reference to the UK, the economic outlook seems rather disconcerting. Despite the UK economy growing at a healthy pace of 0.6% quarter-on-quarter in 2018Q3 (according to official data), propelled by a rise in consumption due to temporary factors - warm weather and Soccer World Cup - and labour market continuing to remain strong, and contributions from trade, it seems to be loosing momentum in 2018Q4 - as Brexit related concerns are increasingly impacting economic activity. 

As an important reflection of how uncertainty over UK’s future trading relationship with the EU is impacting economic activity in the UK, business investment contracted in 2018Q3 for the third consecutive month and at the fastest pace since early 2016. Further, business surveys for October point towards the UK economy slowing down sharply in 2018Q4; activity in the manufacturing and services (the services sector accounts for almost 80% of the UK economy) sectors slowed down markedly in October. Fortunately, for the UK economy, low unemployment and still rapid wage growth should somewhat support consumer spending in 2018Q4. Going forward from hereon to the end of 2019Q1, I expect the UK economy to witness paltry growth, as Brexit related uncertainty is bound to significantly crimp fixed investment and business confidence - at a time when the UK consumer is highly leveraged and sensitive to higher interest rates - and such uncertainty will cause firms to delay hiring decisions. 

Further, going forward, if there is a no-deal Brexit (before the UK leaves the EU in March 2019), which seems a strong possibility (and has the potential to be highly disruptive for the UK economy), coupled with weakening global economic activity and trade, then a protracted economic slowdown or even a ‘recession’ in 2019 is a distinct possibility. This is because business and consumer confidence will be dented significantly, which will result in a slump in business investment spending and sharp retrenchment in consumer spending (due to heightened uncertainty, rising unemployment, fall in property prices and lower real wages - because of probability of higher inflation (as a result of strong possibility of further depreciation of the GBP) and slide in wage growth). Moreover, the UK will face disruption of supply chains and its exports to the EU will possibly plunge.

Emerging Economies - mixed growth prospects, India to remain best performer 

Finally turning to emerging economies, there has been substantial divergence in their macroeconomic performance over 2018 and growth prospects for them in 2019 is mixed. However, taken together, I expect emerging economies to witness slower growth in 2019, relative to 2018. India is very likely to continue to grow over 7% and remain the best performer among these economies in 2019. However, growth is likely to decelerate relative to 2018 - given stresses in the financial sector, continuation of downward pressure on the INR vis-a-vis the US dollar, strong likelihood of escalation of US-China trade related tensions and its downside impact on export growth, rising trade protectionism, possibility of business investment moderating (due to credit slump, heightened uncertainty, higher borrowing costs and probability of more monetary tightening in 2019) and moderately slower consumer spending growth (as consumers are likely to face higher borrowing costs and moderately higher inflation next year).

With reference to other key emerging economies, I expect Indonesia to continue to grow relatively strongly in 2019, Mexico might grow moderately higher next year (though a lot depends on its trade relations with the US and economic policies of the incoming government), Argentina, Brazil and South Africa will probably grow below trend and Turkey could be mired in a deep recession. Next, Asian emerging economies are particularly vulnerable to a slowdown in China and US-China trade related disputes, given their export dependence on China and dangers of disruption of supply chains. Further, with a slowing global economy (particularly towards the latter half of 2019), commodity prices could come under more pressure.This in turn is likely to adversely impact growth prospects of commodity exporting EM economies in Asia, Africa and Latin America - particularly those with relatively weak fiscal positions.