Following a sharp recovery from the financial crisis, the global economy has been cruising steadily ahead since 2010. We’re now approaching the end of that cycle, however, as worldwide growth is anticipated to slow to 3.7% by 2020, according to the International Monetary Fund (IMF).
Importantly, most of that growth will come from emerging markets, which are forecast to expand by at least 4.5% over the next three years, according to the IMF. The outlook for advanced economies is far less rosy, falling from an estimated 2.4% in 2018 to just 1.7% in 2020.
Asia will stand apart over the next few years, with regional GDP growth expected to exceed 5% in both 2019 and 2020, led by India’s rapidly expanding $2.6 trillion economy, which is poised to expand by 7.4% this year. At the same time, Chinese growth is expected to decline to 6.2%, compared to 6.6% in 2018.
Meanwhile, the IMF expects 2019 US growth to slow to 2.5%, the eurozone to dip to 1.9% and Japan – with its ageing population and sclerotic economy – to fall to just 0.9%.
America at work
US unemployment rate
Source: US Bureau of Labor Statistics
Global real GDP growth (annual percentage change)
Leaving the factory ﬂoor
Chinese service-sector employment (percentage of total employment)
Source: Trading Economics
The global economy is now in the late stages of the current economic growth cycle. We are not at the end of that cycle, however. At least not yet.
The United States and China, the driving forces of global growth over the last decade, look set to slow in 2019. That deceleration is being caused by a combination of tighter financial conditions, an end to US stimulus and increased international trade tensions.
The US has been going through one of the longest expansion cycles in history, so it’s unsurprising that momentum is finally starting to slow. The Federal Reserve has been raising interest rates over the last few years in response to that sustained growth – driven by a mix of tax cuts and robust domestic demand – and continued gradual rate hikes are expected in 2019, when the economic cycle is likely to top out.
Some analysts are already warning of a potential US recession in 2020 or 2021. Such fears may be overblown, but two years of political gridlock won’t help matters.
With a Republican-controlled Senate and a Democratic House of Representatives, it will be extremely difficult for President Donald Trump to pass further tax cuts or major spending measures. While the lack of new stimulus will further weigh on the end-of-cycle economy, it could nevertheless contribute to more fiscally responsible policies – very good news for those who fear the longer-term consequences of soaring domestic debt.
In 2017, the US spent $263 billion to service its debt. By 2020, the country will spend more on debt servicing than it will on Medicaid, which covers medical costs for the poor. By 2028, according to the non-partisan Congressional Budget Office, US interest spending is forecast to reach some $915 billion, representing more than 3% of GDP.
Rising US debt, including both the fiscal and current account deficits, will create increasing headwinds for the dollar, which will at the same time be supported by Federal Reserve rate increases.
The outcome of this currency push-and-pull will have global consequences, especially for emerging markets.
A stronger US dollar acts as a tightening measure on emerging-market economies, potentially leading to a reversal of capital flows and making it more expensive for such borrowers to service their debt commitments.
Additional support for the US dollar over the last year has come from stronger economic growth relative to the rest of the world. As the American economy slows, that dynamic appears likely to be less pronounced in 2019. Together with the country’s so-called “twin deficit,” that could lead to downward pressure on the dollar, providing some breathing room for emerging markets.
Our expectation is that the world’s leading reserve currency may strengthen in the first part of the year, then reverse its 2018 gains over the following quarters.
China’s massive economy will also slow in 2019, but not for entirely the same reasons.
While the on going trade war with the US will continue to hit Chinese growth that pales in comparison with the impact of the country’s broader economic transition.
China is in the midst of a decade-long strategic rebalancing from an investment/infrastructure-based economy to one led by consumption. Shifting the country’s focus from state-led investment to service-sector growth, higher consumer spending and greater private entrepreneurship will continue to come at a cost of slower growth.
If the economy slows to uncomfortable levels, expect the authorities to step in, perhaps via tax cuts in order to stimulate spending, rather than through another wave of infrastructure spending and further direct support of the renminbi. That said, a “hard landing” in China is by no means our base-case scenario.
Meanwhile, the ramifications of the Trump-led trade war will continue to be felt well beyond the Far East.
While European auto manufacturers breathed a huge sigh of relief in November when the US president backed down from his threat to impose 25% tariffs on imported cars and car parts, Europe is already feeling the pinch from US tariffs in other areas.
The Bank of England has estimated that a global trade war – in which everyone raises tariffs on everyone else by 10 percentage points – would slow worldwide GDP growth by some 2.5% over three years. Given that the International Monetary Fund expects European growth to decline to just 1.9% in 2019 – down from 2.3% in 2018 and 2.8% in 2017 – the old continent simply cannot afford to be stuck in the middle of an escalating worldwide trade dispute.
Ongoing political uncertainty has been adding to concerns in Europe, delaying major investment decisions and dampening the growth outlook.
On 29 March 2019, the clock that began ticking two years earlier – triggered by the invoking of Article 50 – will strike midnight for the UK. The start of the formal Brexit transition process will provide much-needed certainty and will be supportive for the European economy not long after the European Central Bank’s (ECB) €2.5 trillion quantitative easing program finally comes to an end.
The ECB – whose president, Mario Draghi, will step down at the end of October – may also look to increase key rates in the second half of 2019. So far in this economic cycle, inflation has been “the dog that hasn’t barked.” There are tentative signs, however, that this is beginning to change.
The end of a hot streak?
US real GDP growth (percentage change from preceding quarter)
Source: US Bureau of Economic Analysis
As unemployment levels reach multi-decade lows in many countries, wage inflation has slowly but steadily begun to take hold as employers are forced to offer improved financial packages to retain and attract staff. We therefore expect wage inflation to continue this year, particularly if the price of oil and other key commodities remains firm.
In Japan, a healthy dose of inflation would be very welcome news. While the country’s long battle with deflation has so far proved unsuccessful, an October 2019 consumption tax hike – from 8% to 10% – should help. It remains to be seen, however, how Prime Minister Shinzo Abe will restore confidence in an economy that has been hit by a series of natural disasters, lower consumption and falling capital investment.
A soft landing
Chinese real GDP growth (year-on-year change)
Source: International Monetary Fund
All in all, the outlook for the world in 2019 may sound awfully gloomy. Slower global growth appears to be the new reality, and the risk of US recession may need to be factored into expectations as the year progresses.
While we are late in the economic cycle, however, we are not at the end of it yet.
Reasons for optimism include the record high level of US consumer confidence and the positive global spill over effect of that feel-good factor. Brexit certainty, however painful it may prove for the UK, will support the eurozone.
Importantly as well, 2019 is not a major election year in most nations. That political continuity will contribute to a mood of overall stability, which could positively influence jittery financial markets.
Indeed, after a year marked by a seemingly endless string of mini-crises, the best news we could see in 2019 might just be a lot less news – good, bad, fake or otherwise.
Chief Investment Officer
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