Citadel Chief Economist and Advisory Partner, Maarten Ackerman
We expect reasonable growth from global markets this year but within a more volatile environment. We do, however, expect that these headwinds will eventually slow global activity, likely causing growth around the world to disappoint in late 2019 and early 2020. The real risk for global markets is an unexpected global recession. To monitor this we have developed a global recession scorecard with 10 underlying fundamental indicators. At the moment, 90% of these indicators suggest that a global recession remains unlikely this year.
United States – trade wars or political propaganda?
The economic recovery is continuing unabated in the United States (US), with unemployment declining to decade lows and real wages rebounding to pre-crisis levels. This paved the way for the US Federal Reserve to hike interest rates again at their meeting in March 2018 and to confirm the strategy of another three possible hikes this year, in light of the fact that the US economy is operating close to full employment.
Given this background one needs to ask why the Trump administration has recently announced tariffs on certain imports. Tariffs are normally introduced to protect local jobs from foreign competition or to address structural issues in an economy. Since 1960 the US economy has transformed from a manufacturing- to a services-based economy. Today most jobs and companies are services orientated.
The US is not competitive as a manufacturing hub anymore since there are much cheaper labour pools available around the world. Thus, part of US President Donald Trump’s “trade war” rhetoric is aimed at delivering on his election promise of protectionism and bringing jobs back to the US. Many of the (now retired) former manufacturing workers living in the “rust belt” (previously the industrial and steel manufacturing region in the US) voted for Trump.
Given his unpopularity at the moment, Trump needs to secure these votes again at the upcoming mid-term elections and many of these proposed tariffs are talking directly to these voters’ hearts. Bottom line: The tariffs cover less than 2% of US trade and was watered down by excluding most of the major trade partners – so the economic impact should be marginal and retaliation risk at this point seems low.
The tariffs announced specifically on China are also an attempt to address the US’s significant trade deficit with that country and the fact that China is perceived to be responsible for manufacturing job losses in the US. Once again the tariffs cover less than 3% of US imports from China and less than 10% of Chinese exports. Moreover, even if the actual measures continue to fall well short of the rhetoric, these announcements may weigh on investor sentiment and markets will be more affected than the economy.
Thus, the US economy should still deliver strong growth this year, but the headwinds are picking up, including: tighter monetary policy, late cycle fiscal stimulus, increased inflation concerns and elevated political erosion. The government budget deficit is expected to exceed 5% of gross domestic product by next year, by far the largest while the economy is at full employment since the Second World War. A combination of these should contribute towards growth in the US economy disappointing during 2019, with a possible recession soon thereafter.
Europe – sentiment overshadows political uncertainty
Notwithstanding the political uncertainties in Europe created by the ongoing Brexit negotiations, Germany coalition talks, unsettled voting in Catalonia and the anti-Europe-populist outcome of the Italian elections, business sentiment remains near record highs, which underpins a strong economic momentum.
This trend should continue as unemployment declines further, pushing consumer confidence to pre-crisis levels and raising inflation expectations to three-year highs. Given these developments, European growth should outpace US growth this year. However, a slowdown in the US will unfortunately disrupt the current momentum in the European economy.
Taking into account the present economic environment, the European Central Bank has indicated it is preparing to cut its crisis-era stimulus programme faster than anticipated, joining monetary policymakers in most developed economies in tightening policy.
This should start by reducing and ending quantitative easing as a first step. However, despite the improvement in inflation expectations overall, inflation will take some time to get to target, so the first interest rate cut seems some way off. For now, Europe should deliver a strong performance for 2018, which will support global economic growth.
China – a second term for Xi Jinping
China’s parliament unanimously reappointed Xi Jinping as president while installing one of his most trusted allies as vice president in March 2018. No president in that country has received a unanimous vote in at least a quarter of a century.
Further appointments followed, which saw cabinet being restructured with more reform-minded policymakers. This affirms the country’s focus on quality growth and the desire to promote China’s integration into global financial markets. Soon thereafter the government announced a significant tax reduction package, including a 1% cut in VAT for manufacturing, transportation and telecoms.
These and other changes support the initiative to increase the private sector’s contribution to growth and reduce the need for growth to be supported by government debt. As the economy continues to transform the risk of a major growth disappointment diminishes and the system becomes more sustainable. Given this background we expect economic growth to remain around 6.5% this year and next.
Many of Trump’s imposed tariffs are directed towards China. As mentioned above, so far the tariffs are not a major threat to China’s economy and covers less than 10% of Chinese trade. If these tariffs don’t address the narrowing of the US deficit with China then more aggressive policy might follow, which should escalate trade tensions between the two countries.
In such a scenario the negative impact on growth could also spread to other emerging markets. But, for now, any talk of trade wars is unlikely to have a major impact on emerging market growth for this year.