Growing, But Slowing

A cura di Joachim Fels e Andrew Balls, PIMCO
The much-hyped synchronized global expansion of 2017 has long receded in the rearview mirror as global growth reached its zenith around the turn of the year (see “Peak Growth,” Cyclical Outlook, December 2017). But growth has not only plateaued, it has also become more uneven across regions this year. Accordingly, the current market narrative emphasizes increasing economic divergence and differentiation between and within asset classes, both of which are typical of an aging expansion. We agree, as our regular readers will know.
So much for the nowcast, but what lies ahead for macro and markets over our six- to 12-month cyclical horizon? Are we still at the “beginning of the end” of the economic expansion, as we concluded at our March Cyclical Forum, or is the end near? Conversely, are there reasons to be more optimistic on the growth outlook in the face of tax reform and strong profit and GDP growth in the U.S.? And have the sell-off in emerging markets and the widening in credit and European peripheral spreads created buying opportunities?

Synchronized deceleration

To discuss these and other questions, PIMCO’s investment professionals and several of our trusted senior advisors recently gathered in Newport Beach for the September Cyclical Forum. As some participants noted at the outset, a few of the “rude awakenings” that were incorporated in the longer-term theme coming out of our annual Secular Forum in May have already manifested in the last several months, including the intensification of the China-U.S. trade dispute, the brewing conflict between the EU and the populist Italian government, and of course the recent turmoil in emerging markets – all of which underscore our secular emphasis on caution and liquidity.
We agreed that these recent political and market developments are relevant for the cyclical outlook because they have tightened global financial conditions and increased political and economic uncertainties, which are all likely to damp corporate and consumer “animal spirits” around the world.

“Our cyclical baseline sees this year’s economic divergence giving way to a more synchronized deceleration of growth in 2019.”

Against this backdrop and with the fiscal stimulus in the U.S. starting to fade next year, our cyclical baseline sees this year’s economic divergence – with U.S. growth accelerating but the rest of the world slowing – giving way to a more synchronized deceleration of growth in 2019. In our forecasts, the big three – the U.S., the eurozone and China – should all see lower GDP growth in 2019 than this year: Growing, but slowing.

Fed up

However, economic activity in the major economies, while slowing, is still likely to keep expanding at an above-trend pace and thus absorb more of any remaining slack in labor markets over our cyclical horizon. In response, we expect the major central banks to continue to remove accommodation gradually:

  • Following the expected September increase in the fed funds target range to 2.0% to 2.25%, we expect the Federal Open Market Committee (FOMC) to hike rates three more times by the end of 2019, thus aligning rates with FOMC members’ median estimate of the longer-run neutral rate.
  • In the meantime, while the Federal Reserve will likely continue to run down its balance sheet over our cyclical horizon, it is possible that it ends the process by the end of 2019.
  • We expect the European Central Bank (ECB) to end its net asset purchases by the end of this year but to keep reinvesting maturing bonds for the foreseeable future. A first hike in the deposit rate, which currently stands at minus 40 basis points, looks unlikely before the second half of 2019 and may be delayed even further if core inflation fails to pick up by as much as the ECB staff currently forecasts.
  • The Bank of Japan (BOJ) is likely to stick to its recently introduced soft forward guidance of unchanged official rates – an overnight rate of minus 10 basis points and a 10-year JGB yield of 0% – over our cyclical horizon, but a further tweak in the operational yield curve control policy sometime next year seems likely in order to facilitate a further steepening of the curve that would support Japanese financial institutions.

Two-way risks

In our discussions, we viewed the risks around our “growing but slowing” baseline as broadly symmetric, with trade policy being the main near-term swing factor for better or worse outcomes.

  • Our macro team’s baseline forecasts incorporate the recently announced next round of tariff increases between the U.S. and China – with the U.S. imposing tariffs on an additional $200 billon of imports from China and China retaliating with tariffs on an additional $60 billion of U.S. goods.
  • In a more adverse trade-war scenario, where the U.S. imposes tariffs on all imports from China and introduces tariffs on imported autos and parts from various countries, and the trading partners retaliate with tariffs and, in the case of China, a large currency depreciation, we would expect a sharp slowdown in U.S. and global growth, though an outright recession would still likely be avoided.
  • Conversely, in the event that peace breaks out on trade, deals are done, and all the recently imposed and some of the already existing tariffs are reduced, global growth could be maintained at the current rate over our cyclical horizon.

Other risks we highlighted and discussed at the forum include the brewing conflict in Europe over the Italian budget and potential upside risks to business investment in the U.S. in response to strong earnings growth, deregulation and rising capacity utilization.
Elsewhere, we agreed that the outlook for many emerging market economies remains challenging in an environment of slowing global trade growth, rising U.S. interest rates and domestic political uncertainties. And if the situation in emerging markets continues to deteriorate, it would likely feed back into the U.S. eventually via excessive U.S. dollar strength and weaker global trade growth.

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