Fears of an upcoming recession have increased significantly since the summer. Yet, the economic outlook is far from being as bad as it may seem. The G10 economic surprise index is standing at its highest level since September 2018. It may be seen as a contrarian view, but if you combine this with the monetary push coming from the main global central banks and expectations of fiscal stimulus, then we may very well avoid a recession. At this stage, we cannot exclude the possibility of a positive growth surprise going into 2020.
China: Preparing for slower growth
The latest data confirm that the macroeconomic environment remains challenging for China. China’s credit impulse, which leads the real economy by 9 to 12 months, has improved since Q3 2018, but the inflow of new credit is not stimulating the economy on a broader level yet. Domestic demand is still weak, as pointed out by the latest import figures (Q2 total imports were down 3.9% versus minus 4.4% in Q1) and by the contraction in auto sales (minus 3.4% YoY in August). Compared with previous quarters, data are improving slightly, but the domestic economy is still under severe stress. On top of that, the export industry is suffering from external headwinds, notably the impact of a trade war and lower global growth. The latest new export orders data are slightly better, including for small and medium companies, but they are still deeply in contraction territory. Industrial production is also decelerating sharply, at 4.4% YoY in August, which will weigh negatively on GDP performance in Q3 and Q4 this year.
The stimulus is kicking in well in infrastructure as well as in the real estate sector, which represents roughly 80% of Chinese people’s wealth. Completed investment in real estate – a key driver of growth – continues to grow above 10% YoY, which has been the case almost all year long. I believe that as long as the real estate sector stays robust, China will refrain from a massive easing, something that market participants have been constantly awaiting over the past months. In my view, China is fully aware that a massive credit stimulus program, as was the case in the wake of the global financial crisis, implies high costs for the Chinese economy. Not only it is likely to increase bubbles and misallocation of capital, but, in addition, the effectiveness of credit stimulus is questionable: the country needs twice as many units of credit as in 2009 to create one unit of GDP.
Recent comments from PBoC’s officials to foreign counterparts seem to corroborate this view. Chinese officials are preparing the market for slower growth, probably below 6% next year. They want to make it clear that there is political tolerance for a lower growth level and that it will not be a problem for the economy. At this stage, the market does not seem fully prepared for this shift, so Chinese officials will have to implement the appropriate pedagogy in the coming months in order to avoid negative investor sentiments.
Rest of the world: A welcomed policy reversal
As China is implementing a fine-tuning policy, other countries need to take the lead in order to stimulate the global economy. My bet is on central banks going big in the coming months and fiscal stimulus popping up to cope with China’s lower imports, trade war frictions and a global slowdown. More than 40 central banks over the world have reversed their monetary policy in the past few months in order to ease. As we know, fiscal and monetary push take some time before having a positive effect. In other words, it means it’s going to get worse (Q3-Q4 2019) before it gets better (Q1-Q2 2020).
Our favorite macro gauge, the global credit impulse, which is based on the flow of new credit from the private sector in the 18 biggest economies and expressed as % of GDP, is finally turning upwards again. It leads the real economy by 9 to 12 months and currently points to a potential global growth rebound in H1 2020, mostly driven by the United States. Based on our latest update, US credit impulse stands at its highest level since early 2018, at 1.2% of GDP. The positive trend is also visible in demand for C&I loans, which has been solid over the past quarters, reaching a peak at 9.3% YoY in Q1 2019.
*The global credit impulse series in this document is included as an in-house series. The methodology used to calculate it is explained here. You can see these calculations done using Macrobond in this document (it does not match the above chart exactly as it includes some different countries, but the methodology is the same).
Considering that the United States is in late cycle and impacted by the trade war, its economy is rather resilient: housing data rebounded in August, with positive surprises for building permits and housing starts, and U.S. consumer spending is very strong, probably related to mortgage refinancing and lower rates. It seems that US households are already adjusting to the monetary policy pivot and the new low rate environment, which drive away the specter of recession.
In Europe, I see a technical recession as a done deal for Germany, but not so much for the UK. The combination of stockpiling and positive consumer sentiment ahead of the Brexit deadline could postpone this scenario once again. Despite a broad-based growth slowdown in Europe, I don’t expect much from ongoing debates over 2020 budgets. The problem is that a fiscal push in Europe is dependent on Germany’s good will. In theory, the country could announce a massive fiscal stimulus up to 5% of GDP and still respect the Maastricht criteria. However, based on the latest debates in the Bundestag, that is unlikely to happen. The only events that could change the minds of German politicians and move them away from fiscal conservation are a hard Brexit and/or US tariffs against Europe (following US’s victory in the Airbus case).
In emerging markets, the situation is completely different. Most countries have plenty of room to accommodate the global slowdown. Unlike the period preceding the global financial crisis, no major emerging country is constrained both on the fiscal and monetary space. Some, like Russia and South Korea, can even accommodate on both. What is certain is that we focus a lot on what the ECB and the Fed are doing, but the evolution of global growth will also be very dependent on emerging markets’ policies this time.
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