- The world economy is about to experience a “big switch” in three ways:
- The US/ China switch, a shift in the world growth-maker: Our global macroeconomic scenario bets on a rapid deceleration in the US from 2.9% in 2018 to 2.5% in 2019 and 1.7% in 2020. In the meantime, economic growth in China is set to remain relatively resilient (+6.4%), thanks to a proactive stimulus package (CNY 4.15 trillion, 5% of GDP). As a result, we expect China to replace the US as the main source of global growth in 2019 and 2020.
- The monetary policy switch or a renewed dovishness of central banks: Monetary policy is changing tack around the world. Following a generalized phase of tightening, declining inflation is pushing major central banks to re-explore expansionary moves. Most central banks, including the US Fed and the ECB, have already significantly changed the stance of their communication towards more accommodative orientations.
- The uncertainty switch, a de-escalation of trade risk is possible: This year, trade could experience its own big switch, with a reduction of uncertainty after a phase of accumulating risks (US-China tariffs) that subtracted -0.45 pp from the growth of global trade in 2018. A positive outcome of US-China trade discussions is expected to play a stabilizing role for global trade and growth.
- Emerging markets are best positioned to benefit from the combination of these three factors, and we expect they will be the winners in 2019 and 2020. The “big switch” is also good news for export-driven economies, including those in Europe, which have especially struggled in the face of the US-China trade war and Donald Trump’s threat of tariffs on auto imports. For Germany, which slipped into an industrial recession in the second half of 2018, we think the worst is finally over.
Since Q4 18, the news has been dominated by four main features: a particularly long and brutal government shutdown in the US, a sharp deceleration of growth in the Eurozone, the recovery of the global equity market (in particular emerging equity) - after the selloff of end-2018 - and the confirmation that China has organized a new bazooka fiscal stimulus. All these factors have paved the way for a “big switch” in the global economy in 2019.
The US - China switch, a shift in the world growth maker
US public debt has increased by USD 2 trillion since President Trump took office and a balanced budget is expected only by 2034. This combined with the record high partisanship in the Congress leads us to expect disorderly budget negotiations, leading to new episodes of shutdowns and possible threats of a downgrade of US debt at the end of the year. This shock of uncertainty will impair the investment cycle from Q3 19 onward and stall the US economy in H1 20. We expect a slowdown in growth to +2.5% y/y in 2019 and +1.7% y/y in 2020, compared with +2.9% y/y in 2018.
Meanwhile, China will manage to decelerate at a slower pace in 2019 and 2020, thanks to a powerful policy mix designed primarily to support domestic demand. Different from past expansionary packages, the latest stimulus is more focused and balanced, with 48% based on tax cuts and 52% based on infrastructure spending. Monetary measures are about boosting liquidity in the financial system (Reserve Requirement Ratio cut), increasing banks’ capital, supporting other regulated lenders (financial markets, for e.g.) and improving capital allocation towards the private sector. While the first quarter will likely disappoint due to weaker growth in global trade and slower growth in private consumption, the remainder of the year should see a modest improvement as the government’s stimulus starts to bear fruit.
We expect a modest acceleration of growth in H2 19 (from +6.2% in Q1 to +6.4% in in Q3 and Q4). This will make China a driving force of the global economy with a continued contribution of 1pp to global growth in 2019. The expected powerful impact of China’s stimulus can be illustrated by the strong correlation between China’s aggregate financing to the real economy and the Loan Approval Index. The pace of loan approvals clearly points toward the prospect of an acceleration of total social financing, despite the messages of moderation of authorities in terms of credit policy. Separately, we have calculated the response of world GDP growth to a similar size of Chinese stimulus in the past and got a positive reaction by 0.15 pp at a horizon of three quarters following the budgetary impulse.
The monetary policy switch, a renewed dovishness of central banks
This year has already seen two radical shifts in monetary policy. First, in February, the US Fed advocated “patience” in normalizing its monetary policy and announced that a comeback to pre-crisis level for the size of its balance sheet was not conceivable. This re-orientation took place amid global trade uncertainties, a long-lasting government shutdown (the longest in US economic history) and a concomitant degradation of advanced indicators. In March, Jerome Powell confirmed that it was unlikely to see a rate hike in 2019. At the same time, the Fed also confirmed that the pace at which it is shrinking its asset portfolio will be reduced.
At its March meeting, the ECB chose to jump ahead of the curve with its policy announcements, exceeding already quite dovish market expectations. Based on sharp downgrades to its macro forecasts, in particular for the 2019 outlook, the ECB adjusted its forward guidance, with key interest rates now seen on hold for at least the remainder of 2019. In addition, it also announced another round of TLTRO financing aimed at countering any unwarranted tightening in lending conditions - given the Eurozone banks’ financing cliff in mid-2019 - to ensure the functioning of the monetary policy transmission channel.
The Fed and the ECB aren’t the only central banks adopting a more dovish stance on monetary policies, as seen in our indicator that calculates the average of official rates for 38 different countries. It clearly points to a turning point in the general orientation of monetary policies from November 2018 onwards.
Figure 1: World average official interest rate (%)