Economic Outlook 2019: Reaping the whirlwind

The eye of the cyclone

A cyclone is brewing in the global economy. The US – with its erratic policy-making causing major shocks of uncertainty – is in the eye of the storm, sending headwinds toward the rest of the world.

While China, Japan and the Eurozone are in the stable vortex of the cyclone, able to absorb the shocks, emerging markets are in the unstable vortex, leaving them in a vulnerable position. Nevertheless, we predict the global economy can weather this storm, with world GDP growth expected to remain resilient in 2018 and 2019.

The storm centers on the US, a ‘high pressure economy’ tirelessly creating jobs. Approaching a situation of overheating, the Fed won’t hesitate to tighten its monetary policy, and this could have global repercussions on the most cash dependent economies and companies. The US fiscal policy also plays the role of a powerful absorber of global USD liquidities by offering attractive returns to investors. Beside these centripetal forces, we have also centrifugal forces originating in the US in the form of real and potential threats of protectionism.

The last initiative from President Trump targets USD200bn of Chinese imports, with a 10% tariff to be increased to 25% by the end of 2018. We are now heading close to a scenario where global trade growth could be cut by 2pp should the trade spat between the US and China further deteriorate.

The US economy has positively reacted to the fiscal impulse initiated by President Trump. The current investment cycle remains favorable despite high uncertainty, as the monetary policy remains supportive despite its progressive normalization. The level of US rates, despite worrying signals from the so-called flatness of the yield curve, remains far below the level of household saving rate, which in our view means an extremely low probability of recession.

More interestingly, the US deficit is likely to reach 3.7% of GDP in 2018 and 4.5% of GDP in 2019. The widening deficit, coupled with a tax holiday on foreign profits, has contributed to attract a wave of inward capital flows.

This is triggering a shock on global liquidity, which is at the core of the troubles for the most fragile emerging economies. This disturbance is also accompanied by a huge shock of uncertainty related to the US trade policy.

In our view, these major sources of uncertainty should progressively decrease post mid-term elections. We expect a rebalancing of the US Congress in favor of Democrats with two major consequences: more constraints on the fiscal policy and less severity on trade policy.

This is the reason why we still consider protectionist initiatives by President Trump are more a trade game than a real threat, and that global trade should be preserved, as shown by the real volume of growth remaining in a healthy regime of 2% to 4%. However, the recent implementation of a 10% tariff on USD200bn worth of Chinese imports bring us closer to the trade feud scenario, where global trade could land in the low growth band of 0–2%.
Asia-Pacific to benefit from China’s stabilization

Asia-Pacific economic growth is expected to slow to +4.9% in 2018 and +4.8% in 2019 (from +5.1% in 2017), supported by stabilizing policies in China and Japan. In China, the soft landing is expected to continue, with a growth of +6.6% in 2018 (after +6.9%) and +6.3% in 2019 supported by pro-growth policies.

Fiscal policy is already expansionary, with measures ranging from tax cuts and support for SMEs to infrastructure projects. Monetary policy is set to become more accommodative, with further cuts in the Reserve Requirement Ratio (50bp more) and a gradual boost to credit growth.

On trade, the authorities are multiplying measures to reduce risks related to US protectionist measures. This includes the implementation of new protectionism measures, a depreciation of the currency to preserve exports competitiveness, the acceleration of strategic partnerships to find new growth outlets (e.g. negotiations for the RCEP) and gaining political leverage on the US. In Japan, the BOJ will likely keep its policies accommodative until 2020 in a context of still-below-target inflation, rising external risks and an upcoming hike in the sales tax (October 2019).

Asia as a whole has the room to absorb the impact of Fed hikes. Apart from higher currency risk in markets with twin deficits (e.g. Indonesia, Indonesia, and Philippines), risk on demand growth is relatively contained, as the most vulnerable countries have enough buffers (strong private demand) to support their growth.

The main risk relates to trade. The region can handle the second round effects of a rise of US tariff on USD50bn of imports from China. Yet, it would struggle to cope with much higher tariffs, especially if the tariff hikes were to impact USD200bn at a rate of 25% instead of 10% today (trade feud scenario) or USD500bn (trade war) of Chinese imports. China could lose -0.3pp in the case of a trade Feud scenario and -1pp of GDP growth in the case of trade war. Trade hubs such as Hong Kong, Taiwan and Singapore would be the most affected economies in the region.