global economic outlook and risks - cloudinary · 103 cpi across 9 tariff-impacted categories 11.4...

Global Economic Outlook and RisksMay 2019

Carlos AndradeChief Economist, Novo Banco

The global economy is in a late stage of the cycle. Activity should continue to expand, but at a slower pace. Downside risks have increased.

Late cycle constraints:

• Limited spare capacity

US (Fed Beige Book): “Labor markets remained tight, including notable worker shortages for positions relating to information technology, manufacturing, trucking, restaurants, and p p y

• Scarcer resources

• Higher wages and costs

construction. (…) Wages continued to increase for both low- and high-skilled positions.”

Portugal (BoP Economic Bulletin): “The number of firms ti diffi lti i hi i kill d k i b th

Lower Growth

L t C l

Higher wages and costs

• Less expansionary policies

reporting difficulties in hiring skilled workers is above the historical average. Among the factors limiting production, hiring difficulties are reported as the second most important factor.”

Recovery

Mid-Cycle Late-Cycle

6.67.2

6.27.02018

2019F

Growth

2.9

0 8

1.91.4

2.3

0 61.1 1.2

Recession

GLOBAL ECONOMIC OUTLOOK AND RISKS – May 2019

0.8 0.6

US China Japan Euro Area UK India

. 2 .

Slower activity has been mainly reflecting a convergence towards trend growth. Fundamentals are still supportive of growth.

2 0

2.5US Euro Area

Bloomberg Barclays Corporate High Yield Index (Average Yield, %)

Monetary and financial conditions indicator21

0.5

1.0

1.5

2.0

12

15

18

E

-1.0

-0.5

0.0

RecessionRecession

3

6

9

3.893.86

USEurope

25.9

-1.52000 2002 2004 2006 2008 2010 2012 2014 2016 2018

Unemployment rate (% labour force)Corporate earnings growth (% YoY)

02007 2009 2011 2013 2015 2017 2019

13.114.4

-0.5-1.7

0.6

7.4

1.8

-2 2

3.51.7

7.3 7.7

3.6


-2.2

Q3 2018

Q4 2018

Q1 2019

Q2 2019

Q3 2019

Q4 2019

Q3 2018

Q4 2018

Q1 2019

Q2 2019

Q3 2019

Q4 2019

S&P 500 Eurostoxx 600S&P 500 Eurostoxx 600

. 3 .

Sources: Bloomberg, Macrobond, Factset, Reuters, NB Economic Research.

So far, expectations of a benign economic scenario in 2019 have mostly been confirmed. But exogenous risks, arising from trade and political tensions are becoming more serious

Current activity indicators reflect a convergence of

“BENIGN” 2019 SCENARIOResilient GDP and domestic demand growth in Q1 US and Euro Area continue to create jobs

tensions, are becoming more serious.

• Current activity indicators reflect a convergence of growth towards its trend, i.e. towards more moderate but more sustainable levels. The main economies should continue to expand.

Q1. US and Euro Area continue to create jobs. Downturn in industrial activity associated with specific sectors (autos) and with China deceleration.

• Wages increase, but at moderate rates. Inflation remains contained.

• The US Fed moderates its bullish outlook and slows

~3.5% YoY growth in US wages; ~2%-2.5% growth in Euro Area wages. Inflation close to average. The Fed and the ECB have adopted a more cautious stance and have signalled no further increases in policy rates in 2019.• The US Fed moderates its bullish outlook and slows

down or interrupts its policy rate increases in 2019.

• Financing conditions remain favourable. Corporate credit spreads remain contained Corporate earnings

p y

Positive returns in the main equity indices. Credit spreads remain contained. YoY decline in Q1 2019 earnings but a recovery to single digitcredit spreads remain contained. Corporate earnings

continue to increase, even if at more moderate rates.

• Beyond oil, industrial commodities exhibit a more stable behaviour

2019 earnings, but a recovery to single digit growth is expected ahead).

>30% YTD increase in oil prices (Brent).

5% 7% YTD i th CRB t l d f d i dibehaviour.

• The main political risks (e.g. trade wars, Brexit, Italy) develop into benign outcomes.

~5%-7% YTD in the CRB metal and food indices.

Trade and political tensions are building. Trade wars (US-China, US-EU), Brexit, EU-Italy Budget tensions US Iran military/political

GLOBAL ECONOMIC OUTLOOK AND RISKS – May 2019 . 4 .

Budget tensions, US-Iran military/political tensions, etc. are major downside risks

With higher wage growth (and higher oil prices), why is inflation still low...?

Wage growth(% YoY)

Inflation rate(% YoY)

5.0 6

3 03.54.04.5

3.6

US - Atlanta Fed Median Wage Tracker

3

4

5

6

USUS

2 0

1.52.02.53.0

2.32.4

0

1

22.0

1.7

0.00.51.0

2003 2006 2009 2012 2015 2018

EA - Negotiated wagesEA - Compensation

per employee-3

-2

-1

2007 2009 2011 2013 2015 2017 2019

Euro AreaEuro Area

(i) Globalisation and automation have hurt workers’ bargaining power; (ii) Dominant global firms tend to prevent competition faster productivity growth and higher wage growth;

Sources: Bloomberg, NB Economic Research.

2003 2006 2009 2012 2015 2018 2007 2009 2011 2013 2015 2017 2019

(ii) Dominant global firms tend to prevent competition, faster productivity growth and higher wage growth; (iii) Firms have low pricing power; this may reflect lack of confidence in demand growth, as well as the rise of

digital commerce, which has increased the ability of consumers to find the lowest prices; (iv) Firms have been accommodating higher wages and costs through lower profit margins.


( ) g g g g p g(v) Central Banks have gained more credibility in fighting inflation.

Dovish stance from the main central banks has led to downward revisions in interest rate expectations. p

Market expectations for the 3m EuriborExpectations for the US Fed Funds rate(%)(%)

0.8

1.0

Jul 30th 20182.752.8

3.0FOMC Member Projections

(March)

0.2

0.4

0.6

Jan 28th 20192.38

2.63 2.63

2 292.4

2.6

2.8

0 4

-0.2

0.0

May 24th 20192.06

2.29

1.98 1.94

1 8

2.0

2.2

Market Expectation(OIS, April)


-0.6

-0.4

Jun. 2019 Jun. 2020 Jun. 2021 Jun. 2022

1.68 1.66

1.6

1.8

2019 2020 2021 Long-Run

Market Expectation(OIS, May)

Low inflation expectations and a rise in global risks have led the main central banks to adopt a dovish stance in monetary policy. The US Fed and the ECB have lowered their growth and inflation forecasts and have signalled that there will be no policy rate increases in 2019. The market has reacted by lowering further its expectations for market


p y y g pinterest rates.

. 6 .

An environment of low interest rates should remain in place.

Public debt with negative yields (USD trillion)

10Y Treasury and Bund yields (%)

2 4

2.8

3.2

3.6

US

2.54 10

12

14

1.2

1.6

2.0

2.4

Germany6

8

-0.4

0.0

0.4

0.8y

0.00

0

2

4


Significant liquidity injections by the main central banks have failed to lift inflation and GDP growth significantly This

2014 2015 2016 2017 2019 2014 2015 2016 2017 2018 2019

Significant liquidity injections by the main central banks have failed to lift inflation and GDP growth significantly. This has sparked fears of an economic and financial “ice age” (successive lower highs and lower lows for inflation and nominal GDP growth). This scenario may be exaggerated. But central banks’ dovish stance suggests we should expect low rates for longer.

It could be argued that central bank expansionary policies have contributed to asset price inflation while


It could be argued that central bank expansionary policies have contributed to asset price inflation, while perpetuating inefficient resource allocation.

The environment of low interest rates has contributed to higher debt levels, and search for yield in financial markets has resulted in higher

t l d d hi h i k d btexposure to lower grade and higher risk debt.

Global debt by sector (% GDP)US (investible) corporate bond market (USD trillion)(USD trillion)

95 Non-Financial Corporations8

7 Higher weight of low grade debt

BBB

85

75

G t

Financial Sector

6

5

4

g

A

65

55 Households

Government3

2

1

Sources: IIF, IMF, BIS, NB Economic Research.

1998 2003 2008 2013 2018 2003 2006 2009 2012 2015 2018

451

The more cautious stance in monetary policy adopted by the Fed should prevent a sudden deterioration in credit markets caused by a more aggressive increase in interest rates. However, there is a risk that further downward revisions in earnings growth expectations could lead to corporate rating downgrades. Given the significant increase in

Sources: IIF, IMF, BIS, NB Economic Research.


BBB and HY debt in recent years, this could lead to a more visible deterioration in credit market conditions, supporting a more marked slowdown in economic activity.

. 8 .

Political and trade tensions are looming over the world economy. Higher uncertainty constrains spending decisions and hurts activity growth.

Global policy uncertainty indicatorMonthly data actual and trend

WTO World Trade Outlook Indicator(Trend=100 Quarterly)Monthly data, actual and trend

300

350

102

104

(Trend=100, Quarterly)

Trend

200

250

96

98

100Trend

50

100

150

92

94

9696.3

Sources: Policy Uncertainty, WTO, NB Economic Research.

02012 2013 2014 2015 2016 2017 2018 2019

902017 2018 2019

Political uncertainty related to trade wars, Brexit, rising populism in Europe, etc. is constraining confidence levels and investment spending. Structural adjustments and disruptions in production caused by trade wars have translated into slower growth in China’s economy, with negative impacts on global demand.


The US-China trade war brings disruption to production and supply chains. It leads to lower growth and higher prices.

Manufacturing activity indicators US ISM Manufacturing, Euro Area & China PMI Manufacturing

China – Imports from major trade partners (% YoY)

65US

50

55

60US Euro Area

China

30

35

40

45

US Consumer price index (Feb 2018 = 100)US imports from Vietnam (% YoY)

39 6104

302008 2010 2012 2014 2016 2018

39.6

101

102

103 CPI across 9 tariff-impacted categories

11.4 12.0

6.9

98

99

100

101

CPI, all other core goods


Sources: Bloomberg, Macrobond, Vietnam MPI, NB Economic Research.

-5.6Q1 2018 Q2 2018 Q3 2018 Q4 2018 Q1 2019

982016 2017 2018 2019

Tariffs are a tax on companies and consumers, and its impact will be increasingly felt as the trade war continues. Companies more exposed to t d fl i t d US t iff E ’ t i ktrade flows are more impacted. US tariffs on Europe’s autos are a risk.

Euro Stoxx 600 stock indexG l i d A t (J 2018 100)

S&P 500 earnings and revenue growth Q1 2019 (% YoY)

6.27.3

General index vs. Autos (Jan 2018 = 100)growth, Q1 2019 (% YoY)

105110115

Euro Stoxx 600

0.2

Companies with more than 50%9095

100105 Euro Stoxx 600

Companies with more than 50% of sales in the US

Companies with less than 50% of sales in the US

70758085

Automobilesand parts-12.8

Sources: Bloomberg, FactSet, NB Economic Research.

Earnings Growth Revenue Growth6570

2018 2019

Automobiles and parts

The trade war has a disproportionate impact on manufacturing activity and on the stock market. Tariffs are a tax on companies and consumers, therefore hurting growth expectations. The uncertainty around trade tensions enhance these negative impacts. As the trade war continues and expands, it becomes more difficult to absorb or mitigate its

t Th th t f f t US EU t d t i i i d id i k t th tl k (thi ld i l US t iff


costs. The threat of future US-EU trade tensions is a main downside risk to the outlook (this could involve US tariffs on imports of EU-made cars and parts).

A sharper than expected fall in China’s growth and/or a sudden depreciation of the renminbi would hurt global growth. Emerging

k t d E ld b ti l l h tmarkets and Europe would be particularly hurt.

USD/CNY China’s monthly net purchases of long term US Treasuries (USD billion)long term US Treasuries (USD billion)

15

20

25

7.6

7.8

8.0

0

5

10

15

6 8

7.0

7.2

7.4

6.899

-15

-10

-5

6.2

6.4

6.6

6.8

Sources: Bloomberg, US Treasury, FT, NB Economic Research.

-202017 2018 2019

6.02007 2009 2011 2013 2015 2017 2019

China’s economic growth has been moderating as a result of intended structural adjustments (lower indebtedness, lower investment in excess capacity, smaller shadow banking, etc.). But the negative impacts of the trade war with the US could lead to a faster fall in activity growth, with negative impacts on the global economy. A sharper than expected depreciation of the CNY could lead to financial market instability (e.g. by worsening the outlook for emerging markets).


dep ec at o o t e C cou d ead to a c a a et stab ty (e g by o se g t e out oo o e e g g a ets)And then, there’s the fear of the “atomic bomb”... (i.e. China massively dumping US Treasuries – it holds USD 1.2 trillion, or around 7% of total Treasuries outstanding).

Recent political developments in the UK appear to favour a hard Brexit(or, to a lower extent, a new referendum) vs. a negotiated exit from the EU Th t f EU It l b d t t i i l i kEU. The return of EU-Italy budget tensions is also a risk.

GBP/USD and EUR/GBP10Y Government bond yield spread vs Germany (b )GBP/USD and EUR/GBP vs. Germany (bps)

0.85

0.861 40

1.45

GBP/USD (LHS) 350

400

Portugal Italy

0.87

0.88

0 89

1.35

1.40

200

250

300

Spain

Portugal y

266

0.89

0.90

0.911.25

1.30

EUR/GBP(RHS reversed) 50

100

150109

89462

I l d


0.921.202018 2019

(RHS, reversed)02015 2016 2017 2018 2019

Ireland

The failure to approve the Withdrawal Treaty and the possibility of a new pro-Brexit PM in the UK appear to favour a scenario of a hard (non-negotiated) Brexit. The possibility of a new referendum could also have increased. A negotiated exit from the EU now seems a less probable (although not impossible) scenario. A hard Brexit would increase significantly the probability of a short term recession in the UK and the Euro Area.


g y p yA stronger support to nationalist/populist/anti-integration views in the Euro Area is a negative for the Euro Area outlook. It increases the chances of renewed EU-Italy budget tensions.

MAIN CONCLUSIONS

OUTLOOK

•Fundamentals are still supportive of economic activity: expansionary monetary policies, fiscal stimuli, job creation, wage growth. Normal/low inflation and low interest rates.

B t acti it gro th sho ld moderate as it mo es to ards more s stainable rates i e to ards trend

OU OO

• But activity growth should moderate, as it moves towards more sustainable rates, i.e. towards trend...

• ...And rising political and trade tensions create significant exogenous risks to the outlook. The probability of a downturn/recession in the next 12-24 months has increased.

MAIN (KNOWN) RISKS

• Lower growth Lower earnings Corporate rating downgrades Credit market deterioration Tighter financial conditions; asset revaluation

• Higher inflationary pressures (tariffs, wages, etc.) & low activity growth Lower earnings; constrained central banks; asset revaluation.

• Prolonged and escalating trade wars (US-China, US-EU, tariffs on autos) High uncertainty lower growth; EM instability (China, Turkey, Argentina, etc.); financial market instability

• Hard Brexit short term recession in Europe

B d i i h E A I l i d d fi i l k i bili• Budget tensions in the Euro Area Italy rating downgrade financial market instability

• Other political/geopolitical developments: US-Iran tensions, US debt limit & Government shutdown

• Trade agreements (US-China, US-EU), Soft Brexit higher confidence sustained growth


• Acceleration in productivity growth Cyclical expansion proceeds with low inflation

Research Económico

DPGC

Economic Research

Carlos Almeida Andrade Chief Economist

[email protected] + 351 21 310 64 93

Chief Economist

Tiago Lavrador

[email protected]

+ 351 21 310 64 94

Ana Catarina Silva [email protected] + 351 21 310 64 92

NOVO BANCO DDN – Research Económico

Av. Liberdade, 195, 8º Piso 1250 - 142 Lisboa

PORTUGAL

NOVO BANCODPGC

Economic ResearchAv. Liberdade, 195 – 8th Piso

1250 – 142 LisboaPORTUGAL

. 15 .

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global economic outlook and risks - cloudinary · 103 cpi across 9 tariff-impacted categories 11.4...

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