Global Quarterly Economic Forecast

Tariffs Impart a Chill Wind on Green Shoots

Date Published: June 17, 2019

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Summary

Global economy: At a crossroads

  • The global economy has been unfolding largely as we had anticipated in March. Following last year’s steep deceleration, high-frequency indicators suggest that global growth has stabilized, albeit at a below-trend rate of just above 3%.  
  • Next year, however, the growth outlook has been downgraded by 0.2 percentage points to 3.3%, in part reflecting the recent escalation in trade tensions. 
  • Signs of bottoming in growth have reflected a mix of factors. Recent trade-induced gyrations aside, global financial conditions have eased broadly, driven in part by expectations of lower policy rates. This and other stimulus measures – notably in China – have supported a firming in economic activity. Green shoots have appeared across emerging Asia as well as a number of advanced economies, including core Europe and Canada. 
  • The overall picture masks a continued divergence between manufacturing and service sectors. Global manufacturing activity remains in the doldrums, largely related to trade uncertainty and the knock-on effects of declining auto production in Europe. In contrast, service industries have remained comparatively resilient, particularly in advanced economies. 
  • Trade tensions represent a clear and present danger to the global economy. Our outlook embeds tariffs that have already been implemented, but the threat of further actions – and the potential for an unexpected severe bout of risk aversion – remain key downside risks to the forecast.

Other Forecasts

U.S. economy: Outperformance, but risks loom

  • U.S. economic growth outperformed expectations early in 2019. Real GDP advanced at a 3.1% (annualized) pace in the first quarter, boosted by temporary factors including a significant inventory build. With some reversal, growth is expected to slow in Q2. Still, the first half of the year is tracking 2.5%, roughly a half a percentage point above our prior expectation.
  • This places the 2019 annual average at 2.6% (previously 2.4%).  Economic growth is expected to slow to 1.8% in 2020, as capacity constraints bind.
  • The White House has raised its tariff rate from 10% to 25% on the second tranche of Chinese imports subject to tariffs. Taken by itself, the impact is likely to be relatively small (we estimate a drag if a little over 0.1 percentage points), but much will depend on how spending and investment react to the continued ratcheting up of trade conflicts. Manufacturing sentiment has already begun to converge to lower levels seen abroad. This raises the prospect that another round of tariff action could have a larger impact on economic growth and sentiment relative to last year when both were at higher starting points. 
  • Markets have recently priced as many as four rate cuts  between now and the end of 2020. This aggressive positioning reflects worries of further tariff escalation alongside low inflation and slowing economic growth (both globally and domestic). We believe the market has over-priced the extent of accommodation the Fed will ultimately need or be willing to provide absent a significant deterioration in the economic data. However, the persistent elevated risk environment opens the door for the central bank to take a risk management approach and provide a modest accommodation (50 basis points in cuts) later this year as “insurance”.
  • We expect some semblance of a deal with China to occur this year. Critical to this outcome will be developments that occur from discussions between President Trump and President Xi at the G-20 meeting at the end of June. However, even in the event of a trade deal, it’s unclear at this stage whether the weight on the economy and market sentiment would fully lift. Importantly for the former, a deal would need to unwind the 25% tariffs placed on China in May. In addition, global trade concerns may quickly return to the spotlight with Trump having already signaled a desire to quickly pivot to Europe (a larger export market for the U.S.). 

Canada economy: Between a rock and a hard place

    Economic & Financial Forecasts
      2018 2019F 2020F
    Real GDP (annual % change)      
    Canada 1.9 1.3 1.7
    U.S. 2.9 2.6 1.8
    Canada (rates, %)      
    Overnight Target Rate  1.75 1.75 1.75
    2-yr Govt. Bond Yield  1.86 1.55 1.75
    10-yr Govt. Bond Yield  1.96 1.65 1.95
    U.S. (rates, %)      
    Fed Funds Target Rate  2.50 2.00 2.00
    2-yr Govt. Bond Yield  2.48 2.00 2.20
    10-yr Govt. Bond Yield  2.69 2.30 2.55
     WTI, $US/bbl 59 59 62
     Exchange Rate (USD per CA 0.73 0.77 0.77
    F: Forecast by TD Economics, June 2019; Forecasts for oil price, exchange rate and yields are end-of-period. Source: Bloomberg, Bank of Canada, U.S. Federal Reserve.
  • Canada’s economy has been mired in a soft patch, with real GDP growing just 0.4% (annualized) in the first quarter, following 0.3% in the final quarter of 2018.
  • The weakness in broad output trends has concealed a better story underneath the surface. Notably, domestic demand (spending by households and businesses) rebounded in Q1 and the job market has remained resilient. However, the external backdrop continues to deteriorate in the wake of ongoing trade disputes. 
  • We expect the gap between soft real GDP growth and robust job growth to close over the next few quarters, as output growth picks up somewhat while employment eases to a more sustainable pace. For 2019 as a whole, we anticipate a 1.3% real GDP expansion, while the unemployment rate remains below the 6% mark.
  • It is not assured that the Bank of Canada will follow the Federal Reserve in the event of rate cuts, as markets so often expect. Absent clear evidence of domestic economic deterioration, easing in Canada is unlikely. We hold this view for several reasons. First, after an extended soft path, the domestic data is coming in better than expected in Q2, tracking 2%. This is above the Bank of Canada’s expectation. Second, housing is showing signs of stabilization, and the Bank will want to avoid the risk of re-fuelling leverage dynamics. Third, the policy rate is already lower relative to south of the border.

Global Outlook

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    Chart 1: Persistent uncertainty weighing on global growth
  • Economic growth around the world has evolved in line with our expectations, keeping our 2019 forecast unchanged at a subdued 3.1% (Chart 1). However, the recent escalation of trade conflicts suggests more downside risk to our 2020 view, which we have edged down to 3.3% (from 3.5% previously).
  • Underlying this forecast is an assumption of a more muted rebound in global economic activity in the second half of this year. Trade policy uncertainty is likely to remain elevated even if a deal is struck between the U.S. and China. A number of indicators are signaling that momentum is starting to turn the corner, but it is too early to gauge the robustness of the rebound. 
    • After rising through the first four months of the year, world oil prices have pulled back considerably over the past month, as worries of softening demand have increased. Other commodity prices, including base metals, have been similarly weak, reflecting soft demand and more ample supplies. 
    • Risk appetite and global financial market conditions have improved since early 2019, but have come under pressure as trade conflicts have escalated. However, recent rate cuts by some central banks, and the prospect of Fed cuts later this year, have helped to lift market sentiment (Chart 2). 
    • Consumer and business sentiment surveys have stabilized or edged up from recent lows in most major economies, suggesting greater confidence in the near-term outlook. However, some question marks linger on the European outlook.
    • While remaining at low levels, industrial production appears to be stabilizing in many parts of the world, as are global trade volumes.
    • Real wage growth and job gains have remained healthy in advanced economies, supporting a firming outlook for domestic demand.
Chart 2: Federal reserve expected to cut rates twice this year
  • China’s economic indicators are showing early evidence of responding positively to stimulus, which could alleviate some pressure on key trade partners.
  • Given the precarious state of the global economy, the last thing it needs is an escalation in trade tensions. However, this did not stop the U.S. administration from raising its tariff rate on $200 billion in imports from China to 25% from 10%, and initiating the process to levy a 25% tariff on the remaining $300 billion in imports from China. The first tranche of increased tariffs is likely to shave a bit more than 0.1 percentage points off U.S. growth in the year ahead, with a similar amount hitting back on China.
    • While the economic impacts of the recent escalation may be small, further escalation to apply a 25% tariff rate on the remaining $300 billion would reduce U.S. growth by about 0.3 percentage points over the next year or so, with a similar negative impact estimated for China (Chart 3). Critically, the impact on market sentiment is the wildcard in these estimates. 
    Chart 3: Escalation in U.S.-china tariffs would further chill economic activity
  • China has announced an increase in tariffs of up to 25% (from the previous 5-10% rate) on $60 billion in U.S. goods effective June 1st. Chinese authorities have responded by allowing the renminbi to depreciate as a means to offset the cost of U.S. tariffs. Authorities are also increasing domestic subsidies to the most-affected sectors, and are continuing to impede the activity of U.S. businesses operating in China.
  • As we’ve seen previously, the direct impacts of tariffs (Chart 4) are dwarfed by the indirect impacts that can flow through deterioration in market sentiment and heightened business uncertainty. This is the true wildcard, particularly since we are at an early phase of global recovery after having buckled from past trade action. 
  • Trade negotiations between the U.S. and the EU and Japan are in their early stages. The U.S. administration has threatened to impose tariffs on $11bn in EU goods, and continues to weigh levying auto tariffs. Should negative trade action take place with Europe and/or Japan while issues remain unresolved with China, the stability of the global economy becomes more threatened via the sentiment channel. In addition, both Europe and Japan have a very thin growth-cushion to absorb additional shocks.
  • Growth is expected to remain dichotomous between advanced and emerging market economies. Once again, the U.S. is positioned to outperform its peers this year. At around 2.6%, growth will be slightly softer than last year, but still gap with other advanced economies. This should keep the U.S. dollar well-bid.

Growth to hold below trend in most of the G7

  • The outlook for the G7 economies is broadly similar to our outlook in March:
    • The Euro Area is expected to grow at a 1.2% pace this year. First quarter growth proved a bit stronger than expected as consumer spending and net trade firmed up. However, ongoing weakness in the manufacturing sector may persist into the second half of the year, leaving growth stuck at around its 1.3% quarterly annualized trend pace.
    • The Brexit saga continues, with the exit date pushed to October 31st. This month marks three years of uncertainty about the UK’s future trading relationship with its most important partner. This extended period of uncertainty will continue to weigh on the UK economy for several more quarters. Business and residential investment are expected to remain subdued despite healthy domestic fundamentals. This places the UK growth outlook at just 1.2% in 2019. It will be important to look through the noise in the incoming data. Looming Brexit deadlines drove a surge in imports and inventories at the start of the year that is expected to unwind in the coming quarters.
    Chart 4: U.S.-China tariffs shifting some U.S. imports from China to other Asian trade partners
  • Advanced East Asian economies will continue to face headwinds related to the fallout from escalating U.S.-China trade tensions. Exports of technology goods from Japan, South Korea, and Taiwan have all been affected by the trade spat. With a ramping up in trade tensions, it’s difficult to see growth tick up in Japan to an above-trend pace. As such, Japanese growth is expected to remain choppy this year even before the VAT tax hike is introduced this fall.
  • Oil production curtailments and recent domestic weakness have dampened economic growth in Canada for several quarters. However, recent data support some firming in domestic demand in the March-April period. This is consistent with our view that Canada should be able to produce roughly 1.3% growth this year on strengthening momentum. 
  • Soft inflation and the growth-sapping impacts of escalating trade disputes ensures that G7 central banks will remain on the sidelines in the coming months as they monitor incoming data. The one exception is the Federal Reserve, which has the most room to cut. The Fed is likely to adopt a risk management approach and cut rates later this year.

Hope for an EM rebound

    Chart 5: Global bond yields have eased on growth concerns and trade riskss
  • Economic activity is slowly improving within emerging market economies. Although highly volatile, capital flows have stabilized, and domestic financial conditions have loosened. Moreover, the reemergence of disinflationary pressures ensures that some countries may be able to undertake more stimulus measures, such as policy rate cuts and/or fiscal initiatives. 
  • Emerging East Asian economies with the largest supply chain links with China have slowed in line with expectations at the start of the year. However, forward-looking manufacturing surveys signal a rebound is beginning to take hold on improving domestic demand and Chinese stimulus measures. 
  • There are some signs that Chinese demand is rebounding after slumping in the second half of last year. Past economic stimulus measures are likely playing a role, as are promises by authorities to boost infrastructure spending and help households purchase consumer durables. Manufacturing activity is expanding once again, while consumer and business sentiment is recovering. As a result, we maintain our forecast of 6.2% growth for China’s economy this year, roughly the midpoint of the 6-6.5% range announced by authorities in March. 

Downside risks persist

  • Late cycle dynamics, a build-up in financial vulnerabilities and heightened economic uncertainty have made forecasting more difficult than usual over the past few quarters. Concerns about growth and trade wars have driven down global bond yields back to 2017 levels (Chart 5). Despite early evidence of a pick-up in underlying economic indicators, the pace of economic growth remains lower than in recent years. This leaves many countries with a thinner cushion to absorb economic shocks, be it from trade or geopolitical developments. This places more focus on the potential for additional monetary and fiscal stimulus, and the ability of countries that are already near the zero lower bound and running budget deficits to deliver it (if need be). Rate cuts by the Fed should help cushion some of the downside threat to growth via looser global financial conditions, but are not expected to extinguish the drag on investment and trade from the prolonged period of elevated uncertainty.
  • As the unprecedented and rising amount of negative yielding debt attests (more than US $11tn), monetary policy is still far from normal. Even so, a failure of either economic growth or inflation to increase would hasten pressure for additional stimulus before key advanced economies have lifted rates off the zero lower bound. Europe, with its ailing banks and little room to lower interest rates, is most at risk of falling into recession if demand were to falter. Moreover, fiscal space in the Euro Area is limited to a handful of economies, including Germany, but coalition governments are hesitant to deploy fiscal stimulus. Any missteps by policymakers could result in a sudden repricing of global risk that could derail the global recovery.

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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