Heightened tensions between the US and China are dragging down exports and manufacturing activity. Continued underwhelming macro readings could be the norm in the months ahead. However, we do not think recession is likely as domestic demand remains sustained across the board.
Five key factors at present
Slowdown linked to trade: export orders have slumped as the trade war begins to sap sentiment. Manufacturing has slowed, especially in the most export-sensitive economies. The US-China confrontation is well entrenched and could linger on.
Chinese stimulus: in order to mitigate the impact of higher tariffs on exports, China is likely to ramp up fiscal and monetary easing, although financial stability concerns could prevent authorities from boosting credit massively.
Global capex: spending plans have been hit by the slump in global trade. Supply chain disruption has hurt investment, exacerbating the downside risks for the global economy.
Federal Reserve (Fed) on hold: the central bank is now adopting an increasingly dovish stance, hinting at a possible rate cut given downside risks to growth.
EU politics: politics will remain dominated by Brexit and the budgetary spat between Italy and the Commission.
From trade war to tech war
US China trade negotiations have stalled. We do not expect a quick resolution, with tariffs likely to stick for at least a few more quarters. The tech war may last even longer as both super powers are competing for dominance in sectors such as AI or semiconductors.
Sustained domestic demand
Despite the slowdown in manufacturing, services have so far remained resilient due to robust domestic markets. Consumption is supported by lower unemployment and increased wages in the US and Europe, and by tax cuts in China.
One favourable by-product of the economic slowdown is underwhelming inflation, which is protecting consumers’ purchasing power. Indeed, consumer demand and rising real wages are the anchor for keeping GDP in positive territory in all key regions.
At some point, weak manufacturing may hit hiring, and thus consumption, slowing growth. Recession risks are mounting, though neither the US nor China can afford one, implying a compromise will be necessary.
Monetary policy easing may not be enough
Financial conditions remain accommodative across the board. The Fed’s shift to a dovish stance in 2019 has fuelled market confidence, tightening credit spreads and lifting equity markets. But as rising trade tensions clouded the macro outlook, markets swiftly priced in around four rate cuts on a one-year horizon (since scaled back considerably). The Fed has hinted that cuts are possible, as inflation expectations have dropped sharply, and growth momentum is easing. Indeed, a lingering trade war could further damage macro readings. In the euro area where momentum is turning weaker as well, the European Central Bank has less room for manoeuvre as deposit rates are already negative and a new round of asset purchases is not yet on the cards. Fiscal easing may well prove a necessary adjunct.
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