Key points

  • We downgrade modestly our US growth forecast to 2.2% in 2019 and still do not see a recession over the next 12 months
  • We also reduce our Eurozone growth forecast to 1.2% in 2019, with a challenging external backdrop (read China slowdown) risking to spill over to domestic demand
  • The impact of the Chinese fiscal and monetary stimulus therefore becomes of paramount importance
  • We maintain our limited risk appetite, upgrade Euro IG credit to neutral and emerging debt to

Keep Calm: the US should dodge a recession in the next 12 months

Mindful of the sharp tightening of financial conditions since the publication of our 2019 Outlook[1], we have updated our probabilistic model of US recessions. Clearly, our outlook for the US economy, which was below consensus back in November, was a herald of subsequent market fears. Since the relationship between the recession risk and the market sell-off goes both ways (with our assessment of a causal, rather than casual, link between the UST yield curve inversion and economic recessions[2]), the question was whether market events had overtaken the economic outlook and threatened an even sharper slowdown in activity[3].

Good news: while we estimate that the probability of recession has been rising, it remains below critical thresholds, confirming our assessment that we are moving closer to the end of the cycle. However, our models are not signalling a sharp downturn in the next twelve months. That said, we do expect banks to tighten their lending conditions for households, small and large firms, which we see as the key driver of the US economic slowdown this year and next. As a result, we have revised our outlook for US GDP growth slightly lower to 2.2% for 2019 (from 2.3%). This is even further below the 2.5% consensus, but still, we argue, above the US potential growth rate.

Interestingly, the transmission of this deterioration, from financial conditions to the real economy through the banking system and broader credit conditions, will take a substantial period (several quarters and up to a full year) before it is reflected in the most surveyed economic and market variables. Even a forward-looking indicator like the ISM business survey has historically lagged our recession model by around six months.

Our analyses and forecasts indicate that this reassuring message from the US economy can be extended globally. First, the Eurozone has been slowing dramatically since early 2018 and we expect Italy to fall back into technical recession, while Germany looks set to only narrowly avoid one. But the magnitude of the recent macroeconomic disappointment has been exacerbated by a collection of one-offs: changes to German auto emission standards, Italian budget concerns, the French gilet jaunes disruption… We do expect a modest, upward normalisation in sequential growth ahead. Second, the monthly dataflow from China has been worryingly soft, with trade, for example, free-falling. Here again, we expect data to get worse before they turn better… but the Chinese authorities have already begun to deploy the available arsenal of stimulatory measures, including some monetary easing and a greater boost from fiscal policy, which already appears to have arrested the sharp deceleration in infrastructure spending, but will likely take longer (we estimate until at least the second quarter) to show more obvious signs of traction in the broader economy. “Stability” was a clear key word at the Central Economic Work Conference held at the end of December and we expect Chinese authorities to monitor activity closely to achieve this end. Altogether, we have edged our growth forecasts only slightly lower for the US (2.2%), Eurozone (1.2%) and China (6.1%) for this year. However, we note other forecasters, including the latest International Monetary Fund global forecasts, are moving more quickly towards our view.

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[1] AXA IM Research, “Macroeconomic Outlook 2019: as QE ends, will the global cycle turn?”, November 2018

[2] Page D., Venizelos G. and Savage J., “Is the yield curve pointing to a recession?”, October 2018

[3] Page D., “US to avoid recession, for now”, January 2019


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