The global economy: Rising trade policy uncertainty is weighing heavily on capital spending
During the past two years, news-based and earnings-call-based indexes of trade policy uncertainty (TPU) have both risen sharply and become much more volatile. These indexes measure the number of times trade policy is mentioned in news stories and earnings calls. Indexes of TPU are now three to five times higher than they were in 2015. A recent research paper by IHS Markit estimates the surge in TPU has lowered US capital spending and real GDP by USD100 billion (or 0.5% of GDP). The pain is concentrated in the manufacturing sectors, where the exposure to trade is the greatest. The ramifications for world GDP growth are evident in the IHS Markit projections, which show a big drop from 3.4% in 2017 to 2.5% in 2020.
The United States: Recent data take some of the shine
off the consumer sector.
Real GDP growth slowed to a 2.0% annual rate in the
second quarter, down from 3.1% growth in the first quarter.
Third-quarter data are likely to show a further deceleration. On
the plus side, housing market indicators, including home sales and
housing starts, point to an improved outlook for residential
investment. Data on the US financial accounts through the second
quarter show considerably more household wealth than previously
reported. While this will support consumer spending in quarters to
come, recent monthly data on consumer spending and retail sales
were disappointing. The strike against GM is also estimated to
shave 0.1 percentage point from third-quarter GDP growth. IHS
Markit predicts US real GDP growth will average 2.0% in 2020 and
2021, well below the 2.6% average of the previous two years.
Europe: Reaching stall speed.
Both the hard and soft data underline the weakness of the eurozone
economy. Industrial output, construction, and retail sales have
declined recently. The IHS Markit manufacturing PMI fell to its
lowest level since October 2012 and the service-sector PMI is
retreating. All this listlessness points to flat real GDP in the
third quarter, with contractions in Germany and Italy. Eurozone
real GDP growth is projected to slow from 1.9% in 2018 to 1.1% this
year and 0.8% in 2020. Meanwhile, the United Kingdom has made
little progress toward ratifying a European Union withdrawal
agreement by the 31 October 2019 deadline. Our forecast assumes a
third extension of Article 50 to 31 January 2020 to hold a general
election and (hopefully) break the Brexit gridlock. An agreement is
likely to be eventually ratified. Negligible real GDP growth is
expected in the second half of 2019, followed by a modest
acceleration in early 2020 due to precautionary purchases ahead of
the extended Brexit deadline.
Japan: Will the sales tax hike bring on another
recession? Probably not.
Japan's experience with sales tax hikes in the past three decades
has not been a happy one. The increase from 0% to 3% in 1989 hurt
consumer spending, but the damage was limited, thanks to a booming
economy. The hikes in 1997 (from 3% to 5%) and 2014 (from 5% to 8%)
did more damage. Consumer spending flat-lined after the 1997
increase and fell sharply after the 2014 rise. The sales tax was
raised again on 1 October 2019 from 8% to 10%. The impact this time
around may be more muted thanks to several factors. First, the
Rugby World Cup, now taking place in Japan, has boosted consumer
spending and may offset some negative impacts of the tax increase.
Second, many food and beverage items are exempt. Third, the
government will spend some tax proceeds on childcare and pensions.
Finally, with the government's help, small retailers will offer
customers rebates of up to 5%. These factors mean that, while
Japan's growth is set to slow, a recession is probably not in the
cards.
China: Further evidence of short-term softness and
longer-term challenges.
In recent months, industrial production, fixed-asset investment,
and housing activity have slowed further, and auto sales, exports,
and imports have fallen again. The damage from the trade war is
evident in plunging exports to the United States. Our forecast
shows real GDP growth slowing from 6.6% in 2018 to 6.2% this year
and 5.7% next year. A focus on the short-term fragilities of the
Chinese economy misses the (arguably) more formidable longer-term
challenges. In particular, the large drop in the growth of total
factor productivity—from an annual average rate of over 5% in
the 2000s to 1% in the current decade—is alarming. It suggests
China's model of state-controlled development is running out of
steam and China is at risk of falling into the middle-income trap
of diminished growth potential.
Other large emerging markets: Rate cuts will sustain
growth.
While growth is slowing in all large emerging markets, a series of
rate cuts by their respective central banks will limit the downside
risks—absent a large global shock. India's economic growth
slowed from 5.8% in the March quarter to a six-year low of 5.0%
year on year in the June 2019 quarter. The 135 basis points in
policy rate cuts by the Reserve Bank of India (RBI) this year,
coupled with surplus liquidity in the banking system and corporate
tax cuts, will facilitate investment. Similarly, the Central Bank
of Brazil lowered its Selic interest rate by 50 basis points in
both August and September, bringing it to 5.50%. We anticipate
further reductions to 5.00% before the end of 2019, as inflation
remains low. These steps will help to lift growth a little next
year.
Bottom line
Monetary stimulus, with a possible assist from fiscal
policy, will help to put a floor under global growth so long as the
risks from the trade war can be contained.