Following a disappointing 2018, we expect Eurozone economic growth to drop further in 2019
On balance, we expect the US to avoid recession in both 2019 and 2020, but the risks are set to rise in 2020
The ongoing trade war between US and China is set to create strong headwinds for the Chinese economy in 2019
Beyond extreme quarterly volatility, GDP should expand at a stable rate
The UK may find that whatever the outcome of Brexit, the environment could become more difficult
Trade war, currency shocks and tighter global financing conditions should limit EM growth in 2019
Clouds of uncertainty gather – can the European Central Bank keep its “monetary umbrella” open?
- Following a disappointing 2018, we expect Eurozone economic growth to drop further in 2019 and 2020, respectively to 1.4% and 1.2%, mainly as a result of the weaker external backdrop
- Headline inflation should hover around current levels in the first half of 2019 before moderating on energy base effect. Meanwhile we expect core inflation to gradually and modestly pick up, to 1.2% in 2019 and 1.5% in 2020
- This should prove enough for the European Central Bank to bring the deposit rate to 0% by spring 2020 - arguing that the negative effects of negative interest rate policy are progressively offsetting its benefits. Although we remain sceptical about an “operation twist”, we expect targeted longer- term refinancing operations in the first half of next year
- A heavy political agenda lies ahead, with the European Parliamentary elections in May likely to show further gains for populist parties, and a round of musical chair at top EU posts
A disappointing 2018…
Eurozone economic activity has been disappointing for most of 2018 as some temporary factors distorted growth. These included bad weather conditions and high levels of sick leave in Germany in the context of seasonal flu (Q1 18), strikes in France and accelerating inflation (Q2 18) and disruption in the German car sector due to the introduction of the new European Union (EU) emission certification system (Q3 18). But more importantly, the moderation in 2018 euro area growth to 1.9% has been driven by a less supportive global environment. After a remarkable boost to growth in 2017 of +0.8 percentage points (pp) (Exhibit 1), net trade moderated in 2018, as the pass-through of past euro appreciation, decelerating global trade and rising trade tensions dampened exports growth. Meanwhile, domestic demand proved resilient, helped by a dynamic labour market and very easy credit conditions.
Slow to catch on
- Leaving behind the fastest rate of growth since 2006, we expect growth to come in below consensus at 2.3% next year, before materially decelerating in 2020 at just 1.4% (consensus 1.9%).
- On balance, we expect the US to avoid recession in both 2019 and 2020, but the risks are rising in 2020. Soft landings are indeed historically rare.
- The Fed should tighten policy to 3.00-3.25% by the end of 2019. We change our call to expect a rate cut in H2 2020.
Leaving behind the fastest growth since 2006
2018 looks set to deliver growth of 2.9% – our forecast since February this year – and the market consensus since mid-year (Exhibit 1). This would see US expansion at its fastest rate since 2006 and before the financial crisis. Some of this momentum looks likely to continue into 2019, and the large fiscal expansion that has underpinned growth in 2018 should continue to boost activity in 2019.
Walking a tightrope
- The changing impact of the Sino-US trade war – from a market shock to a growth shock – is set to create strong headwinds for the Chinese economy in 2019
- Beijing is under pressure to steer policy towards growth preservation, but its desire not to reverse structural reforms will limit the vigour of stimulus
- Without a full policy offset, economic growth is expected to slow to 6.1% in 2019 and 2020, with waning inflation
- The changing macro environment will force Beijing to accelerate reforms on multiple fronts
A rocky path to turns rockier in 2019
2018 has been a challenging year for the Chinese economy and financial markets. What got off to a positive start, following the strong momentum of 2017, quickly gave way to a rapid deterioration in economic fundamentals and investor sentiment. A sudden turn for the worse in Sino-US trade relations dealt a heavy blow to Chinese equities and currency. Domestic policies, particularly those centred on deleveraging and shadow-bank controls, also contributed to the negative sentiment by pulling down domestic demand. While macro policies have now been adjusted, we think these changes will be inadequate to reverse the negative growth trend. We expect the economy to end 2018 at 6.5-6.6%, the lowest rate of growth since the global financial crisis.
A little less consumption, a little more action
- Beyond extreme quarterly volatility (natural events in 2018, consumption tax hike in 2019), GDP should expand at a stable 0.9% in 2019
- We expect a significant slowdown in 2020 to 0.5% with the negative tax impact on real income but also a slowdown in corporate investment and public spending
- With low, entrenched expectations, core inflation should remain around 0.5% despite a record-tight labour market
- We expect the BoJ to stick to the Yield Curve Control framework made more permanent last July. The BoJ may also be tempted to exit negative interest rates
As in 2018, GDP growth should remain volatile
The Japanese economy slowed down significantly in 2018, from 1.7% in 2017 to 0.9%, very close to our forecast a year ago (1%). Both household spending and net trade contributed to the softening. Household consumption slowed to 0.4% after 1.0% in 2017, and residential investment contracted -6%, while on the trade front, exports slowed to 3% after growth of almost 7% in 2017. While the fading fiscal stimulus saw public investment contract 2% (and 2.5% in fiscal year (FY) 2018), corporate investment held up surprisingly well and accelerated from 3% in 2017 to 4.5% in 2018.
The UK vs. the EU: Brexit’s final countdown?
- The UK’s economic outlook is materially dependent on how the country leaves the European Union
- A benign, transitional exit remains our central outlook and in this case, we would likely see an acceleration in UK activity in 2019 (1.8%)
- Conversely an abrupt exit would most likely deliver a sharp supply-side shock and a potential recession
- As the UK moves beyond the immediate post-Brexit reaction, the economy will re-synchronise, as the global economy decelerates (1.8% 2020)
Brexit dominates the outlook
The outlook for 2019 and beyond remains dominated by the UK’s decision to leave the European Union (EU) and the path it follows thereafter. We continue to believe the bleak implications that the UK would face, if it left without a deal - and particularly without a transition in March - will force a political acceptance of the arrangement that the government has brokered with the EU (or a mildly amended version).
Accordingly, we envisage that the UK will enter a transitional exit, to a softer end-state than has been suggested for much of the process. Yet such an outcome is far from guaranteed and while the UK and the EU would clearly not choose a more abrupt withdrawal, miscalculation may result in that outcome, meaning there would most likely be materially adverse consequences for the British economy.
Yet looking beyond the short-term uncertainty, the UK may find that whatever the outcome, the environment could become all the more difficult, as global economic activity materially wanes in 2020, as risks of a pernicious global downturn grow.
Economic resilience: It’s a kind of magic
- The seeds of emerging countries’ (EMs) slowdown were sewn back in early 2018 as global financing conditions started to tighten. Growth should nevertheless remain relatively resilient into 2019 albeit showing diverging regional and intra-regional trends.
- Pent-up demand in Brazil or India will help growth gaining traction, while the global economic slowdown will affect most Asian and European EMs. Recessions in Turkey and Argentina (where elections will take place in 2019) should alleviate some of the imbalances, but further policy action is needed to tackle structural issues and credibly anchor expectations.
- The economic outlook remains fragile, threatened by numerous unknowns. Exogenous global factors can significantly affect EMs’ trajectory: stronger US$, higher US Treasuries rates, overshooting oil prices, and a full-blown trade war…
2018: the seeds of the slowdown
The synchronous economic growth rhetoric that was supporting market enthusiasm a year ago vanished. Instead, the sturdy US economy carried on its overextended cycle, thanks to corporate tax cuts. Global financing conditions therefore tightened (dollar appreciation and rising in UST yields), exacerbated in EMs by capital outflows and weighing on EMs’ domestic demand and. Concomitantly, the US administration engaged in trade disputes going well beyond what most initially estimated. Major emerging market (EM) economies such as China, Mexico or Russia, got involved into frictions with the US, being imposed either additional tariffs or targeted sanctions.
The great unwind kicks into gear
- The QE tide is reversing, putting downward pressure on asset prices and upward pressure on correlations
- We take a less positive view of risk assets and look to downgrade equities to neutral over the course of 2019
- We do not expect bund yields to break above the 0.2-0.7% range in 2019 and see value in treasuries above 3.25%
A year of no return
2018 has been a frustrating year for investors. Despite a fair economic backdrop and strong earnings growth in most parts of the world, the performance of global markets was poor. At the time of writing, all major liquid asset classes have posted negative total returns year-to-date (Exhibit 1). While these are expressed in local currency terms, the picture is slightly better for a globally diversified euro investor who has enjoyed the depreciation of the euro against the dollar since the spring. By far the biggest swings have been experienced in commodity markets where oil prices enjoyed a bull run that ended abruptly in October.
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