Window of Weakness
- We believe the global economy is about to enter a low-growth “window of weakness,” a period we expect to persist into 2020.
- In our baseline forecast, the low-growth period of vulnerability over the next several quarters gives way to a moderate recovery in U.S. and global growth in the course of 2020.
- However, our conviction in this baseline economic narrative is lower than usual, given the environment of elevated political uncertainty and fat left and right tail risks.
- During this window of weakness, we think it prudent to focus on capital preservation, to be relatively light in taking top-down macro risk in portfolios, to be cautious on corporate credit and equities, to wait for more clarity, and to take advantage of opportunities as they present themselves.
In the four months since our annual Secular Forum, investors have been busy “ECB Policy: QE Infinity” ).
U.K.: Deal or no deal
We expect an orderly form of Brexit over the cyclical horizon, either through an amended withdrawal agreement or a relatively orderly no-deal exit with side deals or stand-still arrangements in place, mitigating the short-run economic disruption. However, neither a chaotic no-deal nor a revocation of Brexit can be entirely ruled out, so while we have a stable baseline, we are mindful of left and right tail risks of outcomes worse or better than the central baseline.
In our baseline, we expect U.K. GDP growth of 0.75% to 1.25% in 2020, modestly below trend, as headwinds from weak global trade, Brexit-related uncertainty, and possible disturbances in the event of an orderly no-deal exit weigh on growth. Against that, a fiscal boost and resilient consumer will likely provide some support.
Meanwhile, we see core CPI inflation at or close to the 2% target. While wage growth has picked up, we do not expect it to meaningfully feed into higher consumer prices, with firms instead likely to absorb the higher labor costs in their profit margins. In this environment, we expect the Bank of England to keep its policy rate unchanged at 0.75%, but to cut in the event of a no-deal exit.
Japan: External headwinds
We expect GDP growth to slow to a 0.25% to 0.75% range in 2020 from an estimated 1.1% this year. We expect domestic demand to remain resilient thanks to a tight labor market and anticipated fiscal accommodation which would likely more than offset a negative impact of the consumption tax hike planned in October. However, the balance of risk remains on the downside as the Japanese economy faces headwinds from external factors.
Inflation is expected to remain low in a 0.5% to 1% range, with most of the impact from the consumption tax hike to be offset by lower mobile phone charges and free nursery education.
Policy-wise, “fiscal is the new monetary.” Monetary policy is at or close to exhaustion on a standalone basis, but there is clear appetite for fiscal stimulus from both the Bank of Japan and the government. Given external risks are materializing, the likelihood of Bank of Japan action is increasing; however, the hurdle for deeper negative rates remains high from a cost-benefit standpoint.
China: Using the yuan as an automatic stabilizer
We see GDP growth slowing into a 5.0% to 6.0% range in 2020, from an estimated 6.0% this year. The trade conflict escalated after the latest rounds of tariff increases, unemployment is rising, consumption is weakening, property investment has peaked, and business investment remains sluggish. Fiscal policy should provide a partial cushion: We expect fiscal stimulus of around 1.0% GDP for infrastructure and household consumption, likely front-loaded in the first quarter of 2020.
Consumer price inflation in China should remain benign around 1.5% to 2.5% after a temporary disease-related shock increase in pork prices as producer price disinflation is deepening and core inflation is weakening.
Policymakers have been using a flexible exchange rate as an automatic stabilizer. We expect further moderate yuan depreciation against the U.S. dollar as tariffs increase further. This should somewhat cushion the trade war’s impact on manufacturing. In addition, we expect the People’s Bank of China to cut rates by 50 basis points, in addition to reductions in banks’ reserve requirement ratios. However, credit conditions are likely to remain relatively tight and policy transmission slow due to rising defaults and shadow banking deleveraging.
Join us on 15 October 2019 for a live discussion of the key insights from our Cyclical Forum and answers to client questions.
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