Global Quarterly Economic Forecast

Global Economy: Peak Uncertainty

Date Published: March 14, 2019

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Highlights

  • The slowdown in global activity has intensified since November, particularly in Europe and East Asia. This is occurring due to a mix of temporary and more insidious influences that are muddying the waters on the underlying trend. Global economic growth is expected to track roughly 3.2% in 2019, which is a slight mark-down from our previous estimate of 3.4%. 
  • Europe has the misfortune of a collision of two downdrafts. The first includes temporary production disruptions related to new environmental standards. This influence should slowly unwind in 2019. The second downdraft, however, has the potential to be more detrimental to the outlook. Early data signals point to an underlying malaise in core European economies that likely reflects the layering of elevated trade uncertainty, slowing foreign demand, and related declines in consumer and business sentiment. This bears closer monitoring for evidence of stabilization.
  • Peak global uncertainty and slowing economic activity have caused policymakers to pivot towards greater patience. As a result, last year’s global stock selloff has largely reversed, and other measures of financial market stress are easing. This relative calm in the market can easily be disrupted if the economic data consistently disappoint and/or political tensions reignite global uncertainty. 
  • Political trade uncertainty remains the biggest near-term risk to market sentiment and global growth prospects. Despite some optimism recently expressed on a China-U.S. trade compromise, there is little scope for a quick resolution on the weightier topics of corporate malfeasance. Furthermore, a China deal would not remove trade risks altogether. The U.S. administration will then pivot to the EU as its next target. The U.S. continues to wield the threat of auto tariffs to enhance its position in trade negotiations this year.

Other Forecasts

U.S. economy slowing, but resilient

    Economic & Financial Forecasts
      2018 2019F 2020F
    Real GDP (annual % change)      
    Canada 1.8 1.2 1.8
    U.S. 2.9 2.4 2.0
    Canada (rates, %)      
    Overnight Target Rate  1.75 1.75 1.75
    2-yr Govt. Bond Yield  1.86 1.85 1.85
    10-yr Govt. Bond Yield  1.96 2.10 2.10
    U.S. (rates, %)      
    Fed Funds Target Rate  2.50 2.50 2.50
    2-yr Govt. Bond Yield  2.48 2.50 2.50
    10-yr Govt. Bond Yield  2.69 2.85 2.85
     WTI, $US/bbl 59 62 66
     Exchange Rate (USD per CA 0.73 0.75 0.76
    F: Forecast by TD Economics, March 2019; Forecasts for oil price, exchange rate and yields are end-of-period. Source: Bloomberg, Bank of Canada, U.S. Federal Reserve.
  • Economic activity decelerated at the close of 2018, but remained on steady footing at 2.6% in Q4. For the year as a whole, the economy likely expanded by 2.9%. These estimates remained consistent with our December forecast cycle. 
  • The 2019 quarterly GDP pattern carries through a softening trend. This has been a main feature of our forecast for some time, as fiscal and monetary stimulus wanes. The 2019 forecast is tracking a tad softer than in December, at 2.4% (with Q1 carrying an extra weight from the government shutdown). Real GDP in 2020 is projected to be 2.0%, as fiscal stimulus shifts to fiscal drag. 
  • Consumer spending has been a pivotal source of strength in 2018, despite December weakness due to a perfect storm from equity volatility and the government shutdown. Persistent strength in the job market still offers upside risk in this area of our 2019 consumer forecast profile. 
  • In contrast, slower global growth and softer business confidence will manifest in softer business investment in our upcoming forecast. Likewise, housing investment has remained soft, as we expected. The recent drop in mortgage rates should offer a helping hand. 
  • Fiscal policy has not left the landscape as a downside risk. Although a second government shutdown has been averted, a bigger hurdle will present itself at the end of 2019, when Congress needs to reach a new spending deal. The alternative would result in damaging automatic spending cuts taking effect. All else equal, this would significantly compromise our 2020 real GDP growth estimate, bringing it to 1.3%. Given recent difficulties within Washington in agreeing to funding levels for the current fiscal year, this risk is as important as ever. 
  • In the wake of a larger diffusion of softening economic momentum across countries and persistent downside risks, the Federal Reserve has shifted to a wait-and-see stance. We removed rate hikes from our forecast, and any further move is highly conditional on solid economic momentum ultimately feeding into higher inflation expectations, which is currently lacking.   

Canada: consumers set a slower tempo

  • The near-term outlook is unquestionably soft. Broad based weakness within domestic demand has left the economy treading water. Real GDP in Q4 2018 was a mere 0.4% and a slight contraction of output is expected in Q1 2019. However, more positive growth dynamics are expected to take hold thereafter, as oil production curtailment reverses course, and labour markets remain healthy.
  • Near-term pressures constrain our 2019 GDP forecast as a whole to 1.2%, although acceleration to 1.8% is anticipated in 2020. This outlook should be sufficient to keep the unemployment rate near the 5.9% mark.
  • Our greatest current concern resides with the resiliency of Canadian household spending. In recent months, there have been larger than expected disappointments in consumer spending, particularly within purchases that tend to be more hitched to home sales and interest rates. We had always built in a “soft deleveraging” cycle into the forecast, and recent data appear to be playing forward this narrative, but perhaps with more vigour than is preferred. We are looking for confirmation in the data that the solid job market and more benign path for interest rates will remain supportive to the outlook. 

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

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    Chart 1: Global growth resets back to trend in 2019
  • 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. 
  • Chart 2: Central bank pivot to patience keeps rates on hold in 2019
  • 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.
  • Chart 3: Global bond yields head south on low growth and inflation concerns
  • 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

    Chart 4: More fiscal spending expected for the Euro area
  • 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

    Chart 5: China imports from U.S. collapse
  • 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).
  • Chart 6: Chinese stimulus to lift economy in 19Q2
  • 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.

Forecast Tables & Research

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Contributing Authors

  • Beata Caranci, Chief Economist | 416-982-8067

  • Derek Burleton, Deputy Chief Economist | 416-982-2514

  • Fotios Raptis, Senior Economist | 416-982-2556

  • James Marple, Senior Economist | 416-982-2557

  • Leslie Preston, Senior Economist | 416-983-7053

  • Brian DePratto, Senior Economist | 416-944-5069

  • James Orlando, Senior Economist | 416-413-3180

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