Global economy may still defy the pessimists this year

The sharp slowdown late in 2018 has stabilised but not yet reversed


As global economic policymakers gather in Washington for the spring meetings of the IMF and World Bank, a speech by IMF chief Christine Lagarde has warned that the fund’s growth forecasts for 2019 and 2020 will be downgraded next week. While still expecting an anaemic pick-up later this year, she believes that a major fiscal easing may be needed to reverse the downward trend in the longer term.

The IMF warning is consistent with Chris Giles’s latest FT report on the Tiger tracking index. This suggests that the period of synchronised weak growth among the major economies may be difficult to reverse.

Economic commentators are split between the pessimists, who believe that the world economy may even be entering a recession, and optimists, who argue that a reversal of recent policy errors and idiosyncratic shocks in the manufacturing sector will allow a return to trend growth later this year.

Almost no one in policy circles believes that a return to the strong global expansion seen in 2017 is very likely. However, policymakers are often more backward looking than the financial markets, and the recent flow of economic data has not been quite as bad as that seen late in 2018.

According to Fulcrum nowcasts (see box below), the global economy is expanding at 3.1 per cent, towards the bottom end of the 3.0-3.5 per cent band seen in recent months. While this is still half a point below trend growth, and cannot be classified as remotely healthy, it is fractionally above the lowest end of the range.

Among the major economies, the behaviour of China seems likely to be decisive for global growth this year. Here, the latest news seems much improved. The nowcast bottomed at a miserable 4 per cent in December, but it has now rebounded to 5.7 per cent, close to the government’s 6.0-6.5 per cent target range for 2019.

In the advanced economies, the bounce in activity has been much less convincing. Nevertheless, most of the major economies have arrested the downward path for growth, and have begun to recover slightly. The US nowcast is running at 1.8 per cent, compared to a low point of 1.5 per cent. The eurozone is up to 0.5 per cent from a low of 0.3 per cent. And Japan is up to 0.5 per cent after a period in negative territory.

The momentum in consensus forecasts for growth in the world economy has not yet responded to these rather anaemic signs of recovery in the nowcasts. Consensus estimates for output in 2019 have been marked downwards in the US, eurozone and Japan during the first quarter — though, notably, not for China. More encouragingly, the first signs of upgraded projections for China came last week, when JPMorgan shifted its 2019 gross domestic product projection from 6.2 per cent to 6.4 per cent.

The downgrades to growth projections in the advanced economies have been accompanied by surprisingly low core inflation prints in the major economies, raising doubts about the ability of the major central banks to attain their inflation targets. As a result, bond yields have dropped to a worrying extent, and the yield curve has now clearly inverted in the US, adding to recession fears. Pessimists, such as Catherine Mann, chief economist at Citigroup, say that the financial markets are “breaking bad” and that the real economies could shortly follow.

The bear case is based on the continued weakness in global manufacturing and merchandise trade flows. Three factors appear to have been responsible for this:

  • First, business capital expenditure in the global economy is now growing at roughly zero, down from 6 per cent in 2017. This is an unequivocally troubling sign, which follows increased uncertainty about the direction of global economic policy and last year’s tightening in financial conditions.
  • Second, the escalation of American threats about trade wars late last year — covering new, widespread tariffs on Chinese imports, Section 232 tariffs on European car imports, and delays in the new trade deal with Mexico and Canada (USMCA) — seem to have disrupted global supply chains in factory production.
  • Third, there has been a cyclical downturn in IT production in emerging Asia that has not yet decisively hit bottom.

So far, these chilling winds in the manufacturing sectors have not greatly affected service sectors. As confirmed in US jobs data on Friday, labour markets and, therefore, household consumption remain firm in the major economies. However, about 30 per cent of value added in “manufacturing” actually covers business services, and employment in goods production can, obviously, be affected by weak factory output. So the continued immunity of the services sector cannot be taken for granted.

The best antidote to these concerns would of course be a de-escalation of tariff threats from the White House. That does seem to be happening, and investors are very optimistic that a US-China trade deal will be concluded within weeks. The best that can be expected is a standstill on China tariffs, a postponement of European car tariffs, and the eventual signing of the USMCA deal. All of that now seems feasible, if not yet certain.

This would relieve the downward pressure on global manufacturing and capital expenditure, and probably permit a rebound to trend growth in the global economy later this year. Better, but definitely not great, is the likely out-turn for global growth in the remainder of 2019.

Nowcasts and consensus forecasts for the global economy

The Fulcrum nowcasts show that global growth has slowed markedly since the end of 2017 and has moved sideways in a 3.0-3.5 per cent range in 2019 Q1 . . .

Growth in each of the three major advanced economies has rebounded slightly from the recent low points, while China has shown a stronger and more sustained rebound . . .

Recent nowcast data, while a little more encouraging than late last year, have been insufficient to trigger any rise in consensus GDP growth forecasts in the advanced economies, which are still headed slightly downwards . . .

Source: This note is based on material which appeared in an article by Gavyn Davies published in the Financial Times on 7 April 2019.
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