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Global Economic Growth forecast in Q2, 2019: Opportunities and Threats

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The current global economic growth environment remains subdued, and global business sentiment indicators have yet to find a bottom.

However, despite an expected slowdown in economic activities, a recession in the U.S. seems unlikely at this point in time considering the “inverted yield curve”, and the late stage of the business cycle could prevail for more quarters. Emerging markets are most vulnerable to a recession, and the possible escalation of the trade war, coupled with increased protectionist policies by the U.S. will certainly push these markets an inch closer to a recession.

 

Prospects of Major Economies

USA

In the US, the strong fiscal boost of the last two years allowed to further lengthen the already long growth cycle, now standing at 99 uninterrupted months, the longest on record. In the next quarters, however, fading fiscal stimulus and tighter financial conditions will contribute to annual GDP growth slowing from 3.1% in Q4 2018 to around 2% by Q4 2019 – still a not worrying rate of growth. The US economy added a huge 312,000 jobs in December, indicating that the labor market will remain healthy with limited impact on wage growth and inflation. On January 30th, the FOMC (Federal Open Market Committee of the FED) signaled a pause in rate hikes coming forward. On top of that, Chair Jerome Powell insisted during a press conference that the “case for raising interest rates has weakened” due to global crosscurrents and muted inflation. The policy statement and Powell’s comments are unambiguously dovish for monetary policy, and bullish for the equity and bond markets. The Fed is likely to be more flexible in its tightening policy and to hike rates only once this year, most likely by 25bp sometime in Q3. While this dovish move will be beneficial for the growth of the US economy, it also represents recognition that a US slowdown is to be expected.

 

EUROPE

In the European Union, recent data have been quite disappointing as subdued external demand has weighed on the region’s output and undermined sentiment. However, some of the slowdown is related to one-off factors such as the “gilet jaunes” protests in France, the production cuts in the German car sector due to changes in emission regulation and the production and logistic problems in Germany caused by the Rhine draught. The GDP of the European Union has slowed down during the last quarter of 2018 to 1.5%year-on-year, from 1.8% in the third quarter. Nevertheless, while the annual GDP figures for Germany indicate slow growth in Q4 (but not a recession), the Q4 GDP figures show that France proved more resilient than expected, having increased by 0.3% over the quarter, with net trade as the main driver. Spain continues to be a strong performer, registering Q4 GDP growth of 0.7% q/q, up from 0.6% q/q in Q3. Growth was driven by strong exports (1.9%) and robust consumer spending (0.5%). Italy is the most worrying of the big European countries, having entered into recession with two negative consecutive quarters. The comment from ISTAT that net trade gave a positive contribution to growth implies that domestic demand was subdued, on the back of lowering sentiment indicators, especially manufacturing confidence and now also households. Italian growth in 2019 is now expected to be approximately flat.

In a nutshell, as the one-off problems appear to have been resolved, and on the back of a recovery in domestic demand based on signs of stronger wages, lower inflation and a significant fiscal boost (especially in Germany), European growth should hover around 1.5%, just below the 1.8% registered in 2018 overall.

 

UK BREXIT

Earlier in March, we saw historic votes in the UK Parliament to reject the withdrawal agreement for the second time, reject the possibility of the United Kingdom leaving the European Union (EU) without a deal, and an instruction to the prime minister to request an extension to Article 50. After much speculation as to the length of the delay requested, the UK Prime Minister Theresa May requested an extension until June 30 without the possibility for a longer-term extension. After eight hours of debate by the leaders of the rest of the EU on Thursday, March 21, an extension was granted in two forms:

  • An extension to Wednesday, May 22, provided the negotiated withdrawal agreement is approved by the UK Parliament by March 29. In this case, the delay will be needed to allow the United Kingdom to ratify the necessary legislation to give the withdrawal agreement legal effect, including, crucially, the transition arrangements.
  • But if the negotiated deal is not approved by the UK Parliament by March 29, then the extension will be shortened to Friday, April 12. This would be an unconditional extension, but the UK government would then be required to achieve a consensus view and indicate a way forward by the end of it.

 

CHINA

Turning to China, economic growth slowed further in Q4, amid weakening external and internal demand. Growth is likely to remain under pressure at the start of 2019, but find a floor around Q2 in response to an increasing array of growth-supporting measures. Overall, GDP growth is expected to slow to 6.1% this year from 6.6% in 2018. Key risks are trade tensions with the US and a continued tight stance vis-à-vis shadow banking and local government debt. The latest PMI surveys indicate further weakening in industrial activity in December, although the services sector held up well, suggesting that also in China overall growth is not falling sharply.

Recent announcements and statements following December’s Central Economic Work Conference (CEWC) signaled no major shift in macro policy stance. But policymakers have moved to a more growth-supporting macro stance than in 2018. The latest fiscal and monetary steps include a further 100 basis point cut in reserve requirement ratios, new urban railway projects and a quota for local government bond issuance in 2019, which should speed up infrastructure investment. Policymakers will aim to halt the slowdown, rather than try and engineer a significant pick-up in growth.

The gradual policy easing should help China’s GDP growth bottom out around Q2 2019 and would allow economic growth to be in line with a target likely to be set at “6.0%-6.5%”, after “around 6.5%” in 2018. The Central Economic Work Conference (CEWC) gave a mandate for more fiscal and monetary support in 2019 as downward pressure on growth increases. But the desire not to “overdo” it will continue to shape the extent of policy easing.

 

Geo-political developments and risks associated

Geo-politics have played a significant role in determining market movements over the last decade, and investors need to have a thorough understanding of the underlying geo-political situation.

At present, the trade war between the U.S. and China remains one of the most important developments that should be monitored by investors.

The trade war between the two largest economies in the world is finally set to come to an end with the possibility of a trade deal between the two parties becoming a reality. Both of these parties have been involved in a tit-for-tat tariff implementation over the last year, and this contributed significantly to the pessimistic outlook on Asian markets. Now that the trade war is finally expected to come to an end, global markets are expected to regain some lost momentum. However, a trade deal has not been finalized yet, and either party can still withdraw from trade talks at any time. Historically, both parties have failed to reach a middle ground, and there is every possibility of the same thing happening once again. If the trade war does not come to an end anytime soon, it is more likely that we will see a collapse in the Chinese economy, and many sectors in the U.S. will also be hurt severely.

Even as a trade deal is to be signed, investors and analysts are still unaware of the terms and conditions of such a deal, and this puts a question mark over the effectiveness of such a trade deal between the U.S. and China. Protectionist policies by the U.S. have already hurt emerging markets badly, and the failure to end such policies will result in these countries being pushed into recession territory, which would be a negative development for developing countries as well.

Nonetheless, it is believed the possibility of a trade deal is very high, given that both parties understand the dire consequences of failing to come to an agreement soon. U.S. elections are also not far away, and the American President might want to paint a positive picture about the future growth of the American economy to secure his votes, and signing a trade deal with China would be integral to achieve such economic growth. Overall, it is believed the trade tensions have created many investment opportunities, particularly in emerging markets, and investors should be keen to get the most out of such opportunities.

Focusing on the European region, Brexit remains the key geo-political concern. The possibility of a no-deal Brexit is creating panic among British investors, and the overall European region will be hurt badly if Brexit related tensions are not addressed anytime soon. For U.K, neighboring European countries are important trade partners, and the failure to strike a deal before Brexit will hamper economic growth of the region severely, which would be reflected by a regional market rout. European region has underperformed relative to U.S. markets for the last 10 years.

 

 

On top of the uncertainty created by Brexit, there are political woes in France, Italy, and even in Germany, which are all adding up to paint a pessimistic outlook for the future. As revealed earlier, the European Central Bank has already slashed growth projections for 2019, and Euro zone markets are more likely to underperform other regions in the next couple of years.

However, despite the uncertainty surrounding the geo-political situation of the European region, it is believed the region provides a robust investment opportunity for opportunistic investors. Many European markets are trading at low valuation multiples, and investors should consider adding securities from this region to achieve attractive returns once the geo-political situation becomes supportive of regional growth.

The geo-political situation will be a key driver of growth for many emerging markets as well, and history has proven that these countries are extremely vulnerable to instable politics. Escalating problems in the Middle East will especially hurt the regional growth, and needs to be monitored by investors carefully.

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Economy

The path to Global Growth narrows in 2019 after pick up in 2018

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Global growth in 2018 is estimated to be 3.7 percent, as it was last fall, but signs of a slowdown in the second half of 2018 have led to downward revisions for several economies.

Weakness in the second half of 2018 will carry over to coming quarters, with global growth projected to decline to 3.5 percent in 2019 before picking up slightly to 3.6 percent in 2020 (0.2 percentage point and 0.1 percentage point lower).

This growth pattern reflects a persistent decline in the growth rate of advanced economies from above-trend levels—occurring more rapidly than previously anticipated—together with a temporary decline in the growth rate for emerging market and developing economies in 2019, reflecting contractions in Argentina and Turkey, as well as the impact of trade actions on China and other Asian economies.

Specifically, growth in advanced economies is projected to slow from an estimated 2.3 percent in 2018 to 2.0 percent in 2019 and 1.7 percent in 2020.

  • The growth forecast for the United States also remains unchanged. Growth is expected to decline to 2.5 percent in 2019 and soften further to 1.8 percent in 2020 with the unwinding of fiscal stimulus and as the federal funds rate temporarily overshoots the neutral rate of interest. Nevertheless, the projected pace of expansion is above the US economy’s estimated potential growth rate in both years. Strong domestic demand growth will support rising imports and contribute to a widening of the US current account deficit.
  • There is substantial uncertainty around the baseline projection of about 1.5 percent growth in the United Kingdom in 2019-20. The unchanged projection relative to the October 2018 WEO reflects the offsetting negative effect of prolonged uncertainty about the Brexit outcome and the positive impact from fiscal stimulus announced in the 2019 budget. This baseline projection assumes that a Brexit deal is reached in 2019 and that the UK transitions gradually to the new regime. However, as of mid-January, the shape that Brexit will ultimately take remains highly uncertain.
  • Japan’s economy is set to grow by 1.1 percent in 2019 (0.2 percentage point higher than in the October WEO). This revision mainly reflects additional fiscal support to the economy this year, including measures to mitigate the effects of the planned consumption tax rate increase in October 2019. Growth is projected to moderate to 0.5 percent in 2020 (0.2 percentage point higher than in the October 2018 WEO) following the implementation of the mitigating measures.
  • Growth in the euro area is set to moderate from 1.8 percent in 2018 to 1.6 percent in 2019 (0.3 lower than projected last fall) and 1.7 percent in 2020. Growth rates have been marked down for many economies, notably Germany (due to soft private consumption, weak industrial production following the introduction of revised auto emission standards, and subdued foreign demand); Italy (due to weak domestic demand and higher borrowing costs as sovereign yields remain elevated); and France (due to the negative impact of street protests and industrial action).

For the emerging market and developing economy group, growth is expected to tick down to 4.5 percent in 2019 (from 4.6 percent in 2018), before improving to 4.9 percent in 2020.

  • Growth in emerging and developing Asia will dip from 6.5 percent in 2018 to 6.3 percent in 2019 and 6.4 percent in 2020. Despite fiscal stimulus that offsets some of the impact of higher US tariffs, China’s economy will slow due to the combined influence of needed financial regulatory tightening and trade tensions with the United States. India’s economy is poised to pick up in 2019, benefiting from lower oil prices and a slower pace of monetary tightening than previously expected, as inflation pressures ease.
  • Growth in emerging and developing Europe in 2019 is now expected to weaken more than previously anticipated, to 0.7 percent (from 3.8 percent in 2018) despite generally buoyant growth in Central and Eastern Europe, before recovering to 2.4 percent in 2020. The revisions (1.3 percentage point in 2019 and 0.4 percentage point in 2020) are due to a large projected contraction in 2019 and a slower recovery in 2020 in Turkey, amid policy tightening and adjustment to more restrictive external financing conditions.
  • In Latin America, growth is projected to recover over the next two years, from 1.1 percent in 2018 to 2.0 percent in 2019 and 2.5 percent in 2020 (0.2 percentage point weaker for both years than previously expected). The revisions are due to a downgrade in Mexico’s growth prospects in 2019–20, reflecting lower private investment, and an even more severe contraction in Venezuela than previously anticipated. The downgrades are only partially offset by an upward revision to the 2019 forecast for Brazil, where the gradual recovery from the 2015–16 recession is expected to continue. Argentina’s economy will contract in 2019 as tighter policies aimed at reducing imbalances slow domestic demand, before returning to growth in 2020.
  • Growth in the Middle East, North Africa, Afghanistan, and Pakistan region is expected to remain subdued at 2.4 percent in 2019 before recovering to about 3 percent in 2020. Multiple factors weigh on the region’s outlook, including weak oil output growth, which offsets an expected pickup in non-oil activity (Saudi Arabia); tightening financing conditions (Pakistan); US sanctions (Iran); and, across several economies, geopolitical tensions.
  • In sub-Saharan Africa, growth is expected to pick up from 2.9 percent in 2018 to 3.5 percent in 2019, and 3.6 percent in 2020. For both years the projection is 0.3 percentage point lower than last October’s projection, as softening oil prices have caused downward revisions for Angola and Nigeria. The headline numbers for the region mask significant variation in performance, with over one-third of sub-Saharan economies expected to grow above 5 percent in 2019–20.

 

Risks to the Outlook

Key sources of risk to the global outlook are the outcome of trade negotiations and the direction financial conditions will take in months ahead. If countries resolve their differences without raising distortive trade barriers further and market sentiment recovers, then improved confidence and easier financial conditions could reinforce each other to lift growth above the baseline forecast. However, the balance of risks remains skewed to the downside.

Trade tensions.

The November 30 signing of the US-Mexico-Canada free trade agreement (USMCA) to replace NAFTA, the December 1 US-China announcement of a 90-day “truce” on tariff increases, and the announced reduction in Chinese tariffs on US car imports are welcome steps toward de-escalating trade frictions. Final outcomes remain, however, subject to a possibly difficult negotiation process in the case of the US-China dispute and domestic ratification processes for the USMCA.

Thus, global trade, investment, and output remain under threat from policy uncertainty, as well as from other ongoing trade tensions. Failure to resolve differences and a resulting increase in tariff barriers would lead to higher costs of imported intermediate and capital goods and higher final goods prices for consumers.

Beyond these direct impacts, higher trade policy uncertainty and concerns over escalation and retaliation would lower business investment, disrupt supply chains, and slow productivity growth. The resulting depressed outlook for corporate profitability could dent financial market sentiment and further dampen growth

 

Financial market sentiment.

Escalating trade tensions, together with concerns about Italian fiscal policy, worries regarding several emerging markets, and, toward the end of the year, about a US government shutdown, contributed to equity price declines during the second half of 2018. A range of catalyzing events in key systemic economies could spark a broader deterioration in investor sentiment and a sudden, sharp repricing of assets amid elevated debt burdens.

Beyond the possibility of escalating trade tensions and a broader turn in financial market sentiment, other factors adding downside risk to global investment and growth include uncertainty about the policy agenda of new administrations, a protracted US federal government shutdown, as well as geopolitical tensions in the Middle East and East Asia. Risks of a somewhat slower-moving nature include pervasive effects of climate change and ongoing declines in trust of established institutions and political parties.

 

Policy Priorities

With momentum past its peak, risks to global growth skewed to the downside, and policy space limited in many countries, multilateral and domestic policies urgently need to focus on preventing additional deceleration and strengthening resilience. A shared priority is to raise medium-term growth prospects while enhancing economic inclusion.

Multilateral cooperation.

Building on the recent favorable developments noted above, policymakers should cooperate to address sources of dissatisfaction with the rules-based trading system, reduce trade costs, and resolve disagreements without raising tariff and non-tariff barriers. Failure to do so would further destabilize a slowing global economy.

Beyond trade, fostering closer cooperation on a range of issues would help broaden the gains from global economic integration, including: financial regulatory reforms; international taxation and minimizing cross-border avenues for tax evasion; reducing corruption; and strengthening the global financial safety net to reduce the need for countries to self-insure against external shocks.

 

Domestic policies. The policy priorities across advanced economies, emerging markets, and low-income developing countries remain broadly the same.

  • Across advanced economies, above-trend growth is set to moderate to its modest potential (in some cases, earlier than previously anticipated). All countries should emphasize measures that boost productivity, raise labor force participation, particularly of women and, in some cases, youth, and ensure adequate social insurance, including for those vulnerable to structural transformation. Monetary policy should ensure inflation expectations remain anchored, while fiscal policy should build buffers where needed to replenish limited policy space for combating downturns.
  • Emerging market and developing economies have been tested by difficult external conditions over the past few months amid trade tensions, rising US interest rates, dollar appreciation, capital outflows, and volatile oil prices. In some economies, addressing high private debt burdens and balance-sheet currency and maturity mismatches will require strengthening macroprudential frameworks. Exchange rate flexibility can complement these policies by helping to buffer external shocks. Where inflation expectations are well anchored, monetary policy can provide support to domestic activity as needed. Fiscal policy should ensure debt ratios remain sustainable under the more challenging external financial conditions. Improving the targeting of subsidies and rationalizing recurrent expenditures can help preserve capital outlays needed to boost potential growth and social spending to enhance inclusion. For low-income developing countries, concerted efforts in these areas would also help diversify production structures (a pressing imperative for commodity-dependent economies), and their progress toward the UN Sustainable Development Goals.

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