In the latest monthly report on global economic activity, the Fulcrum nowcast models continue to identify a rebound in growth rates after the slowdown that occurred early in 2018. Although there are some preliminary signs of concern in some forward-looking business confidence indicators in the US and China, the latest activity data in both economies point overwhelmingly to firm growth rates.
If the talk of trade wars is destined to damage these major economies, which it may well be, it has not happened yet.
In the eurozone, growth remains much weaker than the rates seen in the second half of 2017. Having said that, the European growth rate has now stabilised around trend, and it is unlikely to fall much further in the context of robust growth in the US and China.
Overall, global activity is growing at 4.4 per cent, about 0.6 per cent above trend, and a full percentage point higher than a couple of months ago.
Of course, there are now quite serious risks to this sanguine view of the present state of global activity. The collision of fiscal stimulus and monetary tightening in the US is presenting increasing headaches for the Federal Reserve, which in the past has found it very difficult to engineer soft landings in the face of similar late cycle challenges.
Furthermore, the sudden increase in the intensity of protectionist threats from the Trump administration in the past few weeks has clearly rattled emerging markets and contributed towards the renewed rise in the dollar.
Although rational economic analysis suggests that the direct damage from any likely rise in global tariff rates should be fairly small relative to the buoyancy of current growth rates in global domestic demand, financial markets could take control and trigger a contractionary shock that economic models fail to predict in advance.
In markets, pessimistic narratives can travel faster, though not necessarily farther, than optimistic narratives, and the plethora of headlines on the dire effects of trade controls is providing plenty of opportunity for pessimism to spread.
As occurred in 2015-16, apparent strains in the Chinese financial system, set against a Fed that seems determined to tighten US monetary conditions, is leading to a simultaneous weakening in Chinese equities and the renminbi. The renminbi has now lost about half of its 2017 gains versus the dollar.
In the past week, financial market flows have been reminiscent of those that occurred during the crisis of early 2016. Outflows from equity funds across the world have been near record levels for this century and capital outflows from China have resumed. Emerging market currencies have declined by about 11 per cent against the dollar since April, forcing a significant tightening in domestic financial conditions in many emerging economies, with policy rates and credit spreads widening, and equities falling sharply.
Although interest rates initially rose only in those economies running current account deficits, policy is now being tightened more widely in economies that were previously believed to have stronger economic fundamentals.
China, with falling policy rates, is the sole exception. But in general there is no denying that the combination of a rising dollar alongside fears of protection is proving toxic for domestic financial conditions in many emerging economies, as might have been expected from previous strong dollar episodes.
So far, activity in the emerging economies has not weakened as financial conditions have darkened. This bears very careful watching, since a response is likely before too long.
Nowcast models are, of course, incapable of forecasting the likely course of global activity at a time, like now, when financial shocks, and offsetting policy changes, are more likely to occur than usual. They are simply not designed to do this.
But nor is any other method very successful in this arena. Mainstream macro-econometric models such as the Fed’s FRBUS model are known to be very bad at predicting major turning points. Meanwhile expert “judgment” is often simply the biased opinion of one individual, based on a selective and impressionistic reading of similar events in history.
There are perverse incentives to stand out from the crowd by reaching eye-catching conclusions. Perhaps some individuals are expert enough to outperform the market in such activities, but the seminal work of Philip Tetlock suggests that it is rather difficult.
In the realm of economic commentary, we are all subject to these pitfalls and this column is certainly no exception. That is why the nowcasts are useful. They employ cold statistical methods to sift through a mountain of recent data in order to report up-to-the-minute estimates of growth rates, making it more possible than previous methods to assess whether the growth rates of the major economies are undergoing important changes.
As the central banks are finding, this is very helpful to policymakers. It is also quite useful for investors, though the nowcast models are certainly not immune from misleading signals.
At present, the main focus is on the two most important protagonists in the trade wars: the US and China. Any decline in activity in either economy would obviously lead to a significant increase in downside risks to global equity and credit markets.
So far, both economies remain strong. In the US, the latest nowcast estimates growth at 3.6 per cent, very close to the average rate recorded this calendar year. This is uncontroversial because it seems broadly consistent with tracking models for GDP growth in the second quarter, such as the Atlanta Fed GDPNow model (3.8 per cent) and the New York Fed nowcasting model (2.8 per cent).
In China, our nowcast is much more surprising, because it reports an uptick in growth to above 8 per cent, while most other economists are talking about a slowdown in retail sales and fixed asset formation, with estimates of the GDP growth rate dipping to about 6.5 per cent. In view of China’s importance, I will analyse these differences in full next week.
Finally, a brief note about the eurozone. Growth dipped sharply in each of the main economies, including Germany, and it is now hovering around trend at 1.8 per cent. The period of European catch-up, seen during 2017, seems to have proven short lived, but recession risks seem distant.