- 2018 saw strong growth while leading to a maximum of uncertainty. World growth in 2018 reached again a high level of +3.1%. Yet it nurtured uncertainties on the possibility of a trade war, non-viable US and European fiscal policies, the Fed’s too high assertiveness, emerging markets’ resilience, the multiplication of political risks and a potential burst of the global credit bubble. 2019 will be a denouement year on all these thorny issues. It should lead to a soft landing of the world economy.
- Pragmatism to prevail in solving trade disputes. Disappointing growth in Q3 and Q4 2018 confirmed that surplus countries could suffer a lot from further deterioration of trade relations with the US. The market’s correction reminded President Trump that US companies won’t be immune in case of a global trade collapse. We see 2019 as a year of risk de-escalation in trade relations.
- Fiscal policies will play the role of a safety valve. President Trump’s turbo charged tax cut program bore fruit in terms of growth but jeopardized sustainability of public debt. On the opposite side fiscal conservativeness was not sustainable for societal reasons in Europe and for preserving growth in China. 2019 will be a year of fiscal re-balancing to the detriment of growth in the US (+2.5% in 2019 vs +2.9% in 2018) and in favor of demand in Europe (+1.6% of growth in 2019 vs +1.9% in 2018) and China (+6.3% in 2019 vs +6.6% in 2018).
- The Fed will be less assertive and alleviate pressures on global liquidity. A disorderly adjustment of the US fiscal policy will be a source of instability requiring the Fed to envisage a maximum of two hikes in 2019 in order to support impaired animal spirits. Risky assets (emerging and credit assets) will find some relief in this.
- Sector risk analysis suggests that the credit bubble is likely to start dis-inflating in an orderly manner. Over the last three quarters leading to Q4 18, sectors downgrades have outpaced upgrades allowing us to pinpoint the peak of the cycle in an early manner. Our growing concern on transportation, construction and car manufacturers re-emphasizes the cyclical nature of these new difficulties. This should adversely impact the global investment cycle in the short-term albeit alleviating pressure in the global credit market over the medium-term.
- Country risk analysis mirrors heterogeneity; in a broadly resilient picture, policy mistakes will remain the separating factor among emerging markets. The change of stance in the US monetary policy will play in favor of emerging economies. In this context, markets will continue to show their capacity to discriminate between sustainable and unsustainable models of growth.
- Alternative scenarios. In case the ongoing US – China negotiations fail, global trade could rapidly head towards a regime of lower growth. The equity market could experience a severe selloff, global credit conditions could significantly tighten. Confronted with mounting risks of recessions, major economies could be exposed to higher deficits hampering their capacity to tame social tensions and political risk. This is a scenario of a forced landing during which the multiple risks coalesce in a very adverse scenario to which we attribute a 25% probability (against 55% in our central case and 15% for a scenario where the global economy overheats in 2019 and consequently experiences a hard landing as a behind the curve Fed briskly tightens its policy). We have also identified 5 different tail risks in which things could turn out even more badly: a generalized trade war, the burst of US credit bubble with a systemic dimension, a default of the Italian debt, a freezing of China’s capital market and a stranded asset shock.
Landing softly in 2019: A drama in five acts
Looking backward on 2018: there is no free lunch
The MSCI world equity index has lost -18.4% of its value between its peak in September 2018 and its most recent trough of January 2019. This significant correction has been the occasion for traditional doomsayers to deliver particularly pessimistic views about the state of the world economy. In our view, this volatility in financial conditions was easily foreseeable and does not really announce a disorderly adjustment of world growth. It is just symptomatic of a transition between the peak of activity after a rare phase of synchronized acceleration in growth in 2016 and 2017 based on the accumulation of both public and private debt, and a phase of de-synchronized deceleration starting in H2 18 resulting from the uncertainty regarding trade issues and a tightening of US monetary policy. As usual, the Fed is shaping and will continue shaping markets and the global cycle. There is no free lunch: accumulating debt is a source of instability and the trigger of this instability is often the tightening of the Fed’s monetary policy.
Looking forward 2019: please don’t panic, this is just the cycle
- Pragmatism to prevail in solving trade disputes
The trade dispute between China and the US has escalated until Q4 18 and is now on pause until March 2 2019, a deadline after which President Trump will decide on whether to implement a rise from 10% to 25% in US tariffs weighing on USD 200 bn of imported Chinese products. In 2018, the average US tariff increased from 3.7% to 5.2%, resulting in a series of retaliations by major trade partners and an overall deceleration of global trade. In our framework, US average tariff delimit thresholds identifying regimes of growth in global trade. Below 6%, we remain in territories where global trade grows at a healthy level (we expect global trade in value to grow by +6.3% in 2019 compared to +7.2% in 2018).
Figure 1: Trade scenarios and impacts on growth
