Summary
- We ended 2018 with a report discussing the many event risks that required political solutions in 2019, from U.S.-China trade tensions, to USMCA, to Brexit. We close 2019 with movement on all three fronts, but not nearly as much as is needed to remove global and business uncertainty and kick-start the investment cycle. But, beggars can’t be choosers.
- Some de-risking in market sentiment is a net positive, but now the ultimate test will be the extent in which it is transmitted into economic outcomes. The wheels were set in motion this year with trade disruptions that not only lingered far longer than expected, but also proved more detrimental to global economic momentum. This led to a series of downgrades, with world real GDP now tracking the slowest pace in a decade at 2.8%. For 2020, we anticipate a modest improvement to 3.0%.
- With interest rates nearing effective lower limits in regions like Europe and Japan, the push is on for more fiscal stimulus. This can turn into a wildcard that generates better economic outcomes in 2020, but based on fiscal plans announced so far, the boost to 2020 global GDP appears similar to that of this year (+0.4 ppts).
- Regionally, the U.S. will continue to lead the G7 in economic growth by a good margin, and recent progress on negotiations with China offer upside potential to near-term exports. However, the absence of a broader trade deal that offers clear line of sight and assurances on the business backdrop is likely to still restrain investment. Plus, trade policy uncertainty will persist with other nations, particularly Europe which is a larger trading partner to the U.S. than China.
- The threat of U.S. auto tariffs on the EU and Japan remains in place, but we are counting on no material tariff escalation to major trading partners during a re-election campaign that could cost jobs in key battleground states.
- Putting aside trade tensions and casting our eyes to other economies, many face idiosyncratic domestic challenges. This is particularly true for emerging markets that face knock-on impacts from a slowing Chinese economy, political unrest, and the risk that nervous investors divert capital at the first sign of trouble.
U.S. Economy: Fed Pivot Shores Up Demand
- At a high level, the American economy has performed close to our expectations in 2019. Growth is on track to slow from 2.9% in 2018 to 2.3% this year. However, beneath the surface, the composition of growth is different from what we expected a year ago in two areas.
- First, the global slowdown and elevated uncertainty stopped business spending in its tracks by mid-year and turned down manufacturing activity.
- Second, the Federal Reserve needed to respond by pivoting to cutting rates (a total of 75 basis points). This succeeded in normalizing the yield curve slope, but we anticipate a relatively flat curve will persist in the absence of compelling evidence of stronger inflationary or economic pressures.
- The good news is that the almighty consumer has responded to the lower rates in textbook fashion by increasing demand for interest-sensitive durables as well as home sales. Continued strength in job markets has also generated a positive impulse for household income and spending growth.
- Provided that inflation remains close to the Fed’s 2% target (as we expect), the central bank is likely to move to the sidelines and patiently observe the interaction of past rate cuts on the economy as well as developments on the global and trade fronts.
Canada: Back To Its Old Ways
- The export-led surge in Canadian economic activity in the second quarter faded as quickly as it developed. The pace of expansion in the third quarter fell back to 1.3% annualized, a subdued rate that we anticipate will be repeated in the final quarter.
- Still, a stronger than thought economic performance in the first half of the year leaves the economy on track to deliver a trend-like 1.7% turnout for this year as a whole. This marks a 0.2 percentage point upgrade from our last estimate, due to upward revisions to history from Statistics Canada.
- Canada’s showing over the next few years is likely to be in line with 2019. Underneath this moderate headline is an economy that remains on two tracks. Labour markets have been strong, but households remain cautious around their spending plans. Housing activity is trending higher, but prospects for other types of investment remain challenging.
- Domestically, stretched balance sheets will play off against rising incomes, including government tax measures. Balance sheet repair is expected to win out in line with recent trends, holding spending growth to a sub-trend pace. Improving housing activity points to an upside risk to this outlook.
- The Bank of Canada remains wedded to holding rates stable, which has resulted in the highest policy rate among its peers and a more persistent inverted yield curve that has only very recently corrected at the 10-year to 3-month spread.
- At its December 4th rate decision, the central bank was more upbeat about the recent economic data, but once again highlighted downside risks to growth from abroad. They are mindful of the potential risk further monetary easing can present to household leverage, given signs of strengthening housing demand.
- We still see the risks tilted towards an insurance rate cut this spring. Beyond the potential for global downside risks to materialize, a possible trigger for an easing could be a desire to offset negative impacts on household finances emanating from rising global bond yields.
- Impeded by ongoing elevated global uncertainty, the Canadian dollar is expected to stay in its recent narrow range of 74-76 US cents.
| Table 1: Economic & Financial Forecasts | |||
| 2019F | 2020F | 2021F | |
| Real GDP (annual % change) | |||
| Canada | 1.7 | 1.6 | 1.8 |
| U.S. | 2.3 | 2.0 | 1.9 |
| Canada (rates, %) | |||
| Overnight Target Rate | 1.75 | 1.50 | 1.50 |
| 2-yr Govt. Bond Yield | 1.70 | 1.45 | 1.65 |
| 10-yr Govt. Bond Yield | 1.65 | 1.65 | 1.90 |
| U.S. (rates, %) | |||
| Fed Funds Target Rate | 1.75 | 1.75 | 2.25 |
| 2-yr Govt. Bond Yield | 1.65 | 1.90 | 2.30 |
| 10-yr Govt. Bond Yield | 1.90 | 2.20 | 2.60 |
| WTI ($US/bbl) | 56 | 59 | 60 |
| Exchange Rate (USD per CA | 0.76 | 0.76 | 0.77 |
| F: Forecast by TD Economics, December 2019; Forecasts for exchange rate and yields are end-of-period. Source: Bloomberg, Bank of Canada, U.S. Federal Reserve. | |||
Global Outlook: Slower for Longer
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- 2019 global growth of 2.8% will mark the weakest rate in a decade. Unfortunately, there is little optimism for a strong rebound in 2020. We see only a modest lift to 3.0% next year, which would still mark a below-trend global pace (Chart 1).
- The forecast reflects weaker-than-expected performances in Europe and Asia through the end of this year, with little momentum to kickoff 2020.
- The global manufacturing slump has intensified in recent months, officially landing on U.S. shores. Automobile manufacturing remains ground zero for the downturn.
- In contrast, tight global labour markets have supported healthy wage gains, helping consumers largely shrug off the woes of the manufacturing sector (Chart 2). But, layoffs in manufacturing industries will test the resilience of the household sector – the keystone to the economic recovery.
- Although some trade-related economic uncertainty has abated in recent weeks, sustainability is key. Also, this impact will play second fiddle to the cyclical downturn in manufacturing and idiosyncratic shocks that have impacted several emerging market economies.
- The announcement of a Phase 1 trade deal between the U.S. and China has removed the threat of more tariffs coming into play, but the devil is in the details. At the time of writing, official communication was elusive on providing specific timetables for tariff roll backs and trade details between the two countries. Nevertheless, the détente in trade tensions is a net positive to market sentiment and marks a de-risking of the global backdrop. This assumes the U.S. does not pivot to Europe on aggressive tariff action.
- In the event that negative trade action takes place with Europe, it could mark the tipping point for Europe into a recession and once again undermine the stability of the global economy (including the U.S.) via the sentiment channel.
- Aside from trade, other downside risks linger, dampening growth and are likely to contribute to bouts of financial market volatility. These include geopolitical hotspots (Hong Kong, Iran, North Korea, Venezuela) and more recently popular protests in Bolivia, Chile, Lebanon and France.
- With below-trend growth persisting in a number of regions, there is little cushion to offset unanticipated shocks. In the G7, the risk of a further deterioration in economic activity is highest for the Euro Area (Germany and Italy) and the UK. In emerging markets, the risk is highest in Mexico and Brazil. Policymakers have reacted by cutting interest rates and committing to various fiscal packages, but economic growth is at risk of getting worse before improving.
Europe and Japan Weighing Most on G7 Growth
- The downturn in the European manufacturing sector has intensified and spread beyond Germany and Italy. As a result, Euro Area growth has slumped to a below-trend pace, with growth being kept afloat by a resilient consumer.
- In response, the ECB has delivered some stimulus by cutting the deposit rate by 10 basis points (to -0.5%) and restarted asset purchases equating to about €60bn per quarter. In addition, budgets announced this fall by member nations should help boost growth by about 0.2-0.3 percentage points next year (Chart 3). Nevertheless, this may still prove inadequate to prevent the Euro Area from slipping into a deeper economic downturn, especially if external demand falters further.
- After running hot in the first half of the year, Japan’s economy has since weakened with the fourth quarter set to contract, as consumer spending adjusts to a rise in the value-added tax rate. Fiscal spending amounting to US $239bn has been announced as a means to support demand currently and after the 2020 Summer Olympics, the largest such fiscal package since 2016. Nevertheless, growth next year is likely to decelerate from this year’s 1.2% pace.
- In the UK, parliament has agreed to a withdrawal agreement with the EU, but a conclusion to the Brexit saga remains elusive. The strong Conservative majority election victory last week should ensure that PM Boris Johnson’s withdrawal agreement passes parliament by the January 31st deadline. Still, even with an agreement to leave in hand, the future trading relationship between the UK and the EU will still need to be redefined. As a result, the associated prolonged period of uncertainty should continue to weigh on the economy, keeping growth at or below 1% next year.
EMs Hampered by Domestic Concerns
- Emerging Market Economies (EMEs) remain challenged on a number of fronts. Although the low inflation environment has enabled policymakers to react by injecting stimulus (lower policy rates, increased fiscal spending), idiosyncratic challenges and the potential for an escalation in trade tensions threaten their outlook.
- Latin America is mired in an economic downturn, with crises in Argentina and Venezuela weighing on the outlook for the wider region.
- Both India and China are struggling to boost economic activity. India is working its way through a bank credit crunch, while China’s structural economic slowdown continues, exacerbated by U.S. tariffs.
- Even east Asian economies, some of which have benefitted from the trade diversion due to U.S.-China trade tensions, have been caught in the global manufacturing slowdown.
- Chinese demand seasonally slows every winter, but higher frequency indicators suggest that the economy has slowed more than expected in the past few months. In response, policymakers have begun to more aggressively cut the price of bank credit, and local government fiscal expenditures are expected to ramp up in the months ahead. Encouragingly, manufacturing and services industry sentiment is improving, signalling that past stimulus efforts may be starting to bear fruit. In addition, the much vaunted “Phase 1” trade deal and ongoing trade talks with the U.S. should further inject more confidence in Chinese firms and households, providing upside risk on economic activity. Overall, we have marked down our outlook for Chinese economic growth to 5.9% in 2020, a tenth of a point weaker than our previous forecast and the slowest pace since 1990 (3.9%).
- The outlook for China is contingent on authorities being able to manage ongoing financial stability concerns. Corporate defaults have been on the rise, and banking authorities have been diligent in bailing out troubled banks. Managing these risks while addressing U.S. trade-related issues will be key to successfully steering the economy to a soft landing.
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