The brutal financial market moves of the past month or so clearly suggest that markets have re-evaluated considerably the outlook for this year, cementing the general narrative that 2019 will be a tricky year. The US yield curve has inverted at the short end – markets now expect the next rate move by the Fed to be a cut – and we expect further hikes to be pushed back into 2019.
In addition, the recent plunge in the S&P 500 suggests that markets are preparing for downside surprises on the economic front. Looking through the rear-view mirror at the published economic data suggests that recent market moves are an over-reaction to recent events. Admittedly, five large advanced economies contracted in Q3 and there does appear to be a broad-based loss of momentum – the bulk of the manufacturing PMIs have fallen over the past three months and trade indicators continue to point to a slowdown in global trade.
But the Q3 GDP falls were by and large caused by temporary one-off factors. Meanwhile, the levels of many of the key business surveys are generally still consistent with solid, albeit slower, growth and our advanced leading indicator model, which uses both hard and soft data, paints a similar picture. Our own forecasts assume that global GDP growth slows from 3% in 2018 to 2.7% in 2019.
In addition to ongoing geopolitical uncertainties and monetary policy and liquidity concerns, this apparent disconnect may partly reflect that the recent data provide mixed signals. On the one hand, for now, the data still point to fairly solid growth. But for markets, which are concerned more about the second differential (the change in the rate of change), developments such as the sharpest monthly fall in the US manufacturing ISM since October 2008 point to an alarming loss of growth momentum.
Whether or not we have reached a position where material revisions to our growth forecasts are warranted depends on two key judgements: a) have other downward forces on growth increased by more than we had already built into our forecasts?; and b) will the financial market weakness seen so far have material spill overs on to the real economy? Although much has been made of the loss of momentum in the US and Chinese economic data recently, our forecasts already assume some softening of growth around the turn of the year.
In our view, there is not yet compelling evidence that the latest news points to a more substantive loss of momentum than assumed in our baseline. And in any case, rather than being a cause for alarm, managed slowdowns in the US and China are necessary to reduce the risk of building instabilities that could exacerbate recession risk further ahead.
On China, a particular concern has been the apparent inability of policymakers to fine-tune GDP growth. Our view is still that Chinese policymakers can and will support growth, but that they will seek not to overdo it. The lack of a turnaround so far reflects a combination of prior policy tightening still feeding through to the economy when policy started to be loosened and the slow, incremental nature of the recent easing.
While we see growth slowing further in the short term, it is likely to stabilise in Q2. Meanwhile, our view is that the 2018 financial market weakness is likely to have only a moderate negative impact on advanced economy growth this year – further falls will be needed to have a material impact. Counterfactual model simulations suggests that the asset price ‘surprises’ in 2018 might reduce GDP growth in the advanced economies by 0.2pp in 2019. In addition, these simulations also fail to consider the recent fall in the oil price which should lower inflation and boost households’ real incomes.