Global Quarterly Economic Forecast

Global Outlook: Hit The Reset Button...Please!

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• A deceleration in advanced economy growth has driven the markdown in our global growth forecast to 3.2% this year (Chart 1), versus 3.4% in December.
• Early warning indicators do not signal an imminent  global recession, however we are concerned about Europe’s sudden and dramatic slowdown toward the end of last year. We have long said that the first quarter of 2019 will be the make-or-break quarter of defining direction due to the lengthy period of high event risks that are bleeding into business sentiment and greater market risk-aversion. This has become more pressing. 
• Globally, the manufacturing and trade sectors are bearing the weight of unresolved political outcomes, and it is now a question of how much longer other supportive fundamentals - such as falling unemployment and firming real wage gains - can remain in place. 

• The long passage of time with ongoing U.S.-China trade policy uncertainty is taking a toll on EM economies. In turn, the manufacturing slump is impacting advanced economies in Europe and developed Asia. Relatively lower linkages to EMs has created more resilience in the U.S., but it too is losing some steam. The U.S. is better positioned to continue to outperform its peers, but not with the same degree of vigor as that of 2018 when annual GDP growth neared 3%. Nevertheless, there will be sufficient growth-divergence to maintain a strong U.S. dollar under favorable interest rate differentials relative to peers and safe haven bids. 
• Disappointing growth, subdued inflation, and an intensification of downside risks have prompted policymakers to pivot away from a tightening bias (Chart 2) The Federal Reserve, Bank of Canada, Bank of England, and Reserve Bank of Australia are among the advanced economy central banks that have recently emphasized the need for patience in order to assess data developments. Thanks to subdued price pressures, emerging market (EM) central banks are also pivoting toward more stimulus, as evidenced by the Reserve Bank of India’s unexpected rate cut in February.

• This shift towards greater patience has been a key catalyst to renewing investor risk appetite. The rebound in global equity markets has largely offset last fall’s slump. However, commodity and bond markets are holding on to more skepticism, as the change in central bank tone ultimately signals greater concern (Chart 3). A realization of any of the many negative event risks dotting the landscape or further economic deterioration would reinject financial market volatility.
• All told, we lean towards a recovery in global economic activity later this year, as more stimulative economic policies take hold (i.e. China, India and other EMs, looser fiscal policies in Europe), one-off factors roll out of the data, and (hopefully) politically-induced economic uncertainty abates.

G7 growth falters

• Since November, a number of negative developments have come to the forefront on the European outlook.
• New emissions regulations that took hold in September resulted in a more pronounced decline in industrial production and automotive sales. Although auto production and sales are starting to rebound, they have yet to recover to pre-September levels. Other peculiar factors, such as low water levels in the Rhine River and ongoing weekend protests in France, have dealt other temporary blows to both the manufacturing and service industries.
• The unwinding of these one-off factors should alleviate, but not fully eliminate, pressure on activity. Slowing European growth raises the odds of more fiscal stimulus occurring across the continent. The fiscal impulse is already expected to prove more positive than in previous years due to tax reforms and greater spending plans (Chart 4). We foresee Euro Area growth at 1.1% for 2019, a downgrade from our previous forecast of 1.5%.
• Prolonged Brexit-related uncertainty is not helping matters and is starting to bear more weight on UK economic activity. An expected deterioration in business investment growth is now being mirrored by softening consumer spending, despite solid employment and real wage gains. The UK economic forecast has also been downgraded to a 1.2% pace in 2019, versus a 1.6% previous forecast. 
• Outside of Europe, softer foreign demand, particularly among East Asian trading partners, has dampened the outlook for Japanese exports and thereby intensified the downside risks. We anticipate growth to remain choppy in Japan due to spending on Olympics-related infrastructure combined with distortions created by the VAT increase scheduled this fall.
• In Canada, weaker consumer spending and a recent oil output curtailment are taking a heavy toll on the 2019 outlook. Among the G7 economies, this forecast has suffered one of the larger downward revisions, to an annual pace of 1.2% in 2019 versus 1.5% prior.    
• Downgrades to the global outlook reduce the risk of higher inflationary pressures, providing sufficient cover for G7 central banks to stay on the sidelines until the data suggests otherwise. This evidence is unlikely to be of a convincing nature until at least the second half of 2019, as the influence of temporary factors and policy shocks begin to abate. In turn, we have delayed or removed any further central bank rate hikes. In particular, the Bank of Canada is unlikely to find itself in a position of needing to address high inflationary pressures due to a wider output gap. We have removed all further rate hikes from the forecast profile; a 1.75% policy rate is as good as it gets.
• There is slightly more scope for the Federal Reserve to nudge rates up given the greater likelihood of a return to above-trend economic growth. However, they too would only do so in the event of threatening inflationary pressures to the outlook. The ECB has signalled patience until 2020 on any rate decision, while Japanese monetary policy is expected to also remain highly stimulative through 2020.

Seeds sown for an EM rebound this spring

• There’s no question of greater synchronicity in the slowdown among EM economies since November, but not all the edges continue to fray. At the very least, capital flows have stabilized on easing financial market concerns over an overly-aggressive U.S. rate hike cycle. It is important for this to hold in order to mitigate a key area of near-term financial risk.
• Countries with the greatest dependency on Chinese demand are experiencing a sharper deterioration in sentiment and economic activity. This is captured within forward-looking PMIs in EM Asia. Weaker export orders and contracting manufacturing activity reflect the crosswinds from a cyclical slowdown (after a mini-boom in 2017-early 2018), made stronger by the fallout from currency depreciation, capital outflows and elevated trade uncertainty. Europe’s higher trade export-dependence with EMs relative to the U.S. and Canada leaves it more exposed to flagging growth (Chart 5).

• Investor concerns over the slowdown in Chinese economic activity have intensified due to indicators showing softening consumer spending and sentiment, alongside rising corporate defaults. However, we suspect this trend has more to do with past measures put in place by authorities to rein in credit growth than recent tariff measures (see our recent report). True to fashion, authorities have quickly responded to concerns by announcing stimulus measures, including greater lending to small and medium sized businesses, and infrastructure spending (Chart 6). This is one economy where our forecast has changed very little in the past three months. We continue to expect China to expand at a 6.2% pace this year. This is four-tenths weaker than in 2018, but consistent with the state growth target of between 6 and 6.5%.

No relief in downside risks

• On December 10th 2018, we published a report called “2019: The Year Of The Deal”. In it, we noted that the recent loss in global economic momentum was not extreme by historical standards, but required close monitoring due to the negative interplay between event-risk and late-business cycle dynamics. The global growth cushion is becoming thinner to absorb shocks, and the runway to resolving political risks is getting shorter. Three months since that report, little has changed on our “prominent risk-list” to the global economy. 
• Brexit: As the UK Parliament continues to debate the withdrawal agreement, uncertainty is clearly taking a toll on the economy. The March 29th deadline is fast approaching, raising the odds of either a last-minute deal, an extension, or both. Either way, the longer that the economic relationship of the UK to mainland Europe remains undefined, the greater the toll on the domestic economy, and potentially also business sentiment across Europe. 
• China-U.S. trade tensions remain unresolved, despite some positive headlines of a forthcoming deal. Financial markets need full resolution, as there have been many head-fakes in the past. In the meantime, lingering uncertainty and trade flow disruptions will persist, particularly with European and Japanese trade now in the U.S. line-of-sight, where threats of auto tariffs continue to be dangled.    
• Lastly, it appears that central banks have at least side-stepped a near term threat of over-tightening within this “Great Unwind” phase of the cycle, but only time will tell if they’ve hit the mark. Any missteps by policymakers could result in a sudden repricing of global risk.