Will the most recent policy changes from central banks turn the tide on global growth?
Q: From trade to Brexit, there’s a lot of issues hanging over markets now. Can you update us on your macro outlook, starting with a quick review of the past, in order to put some of these events into context?
What I've emphasized in previous outlooks is that the driving factors behind this slowdown have been principally driven by policy. Beginning in 2018, the Federal Reserve tried to normalize interest rates and went too far too fast. A lot of the volatility in the fourth quarter of 2018 was associated with Fed Chair Powell's statement that he believed that the neutral rate was significantly higher than prevailing interest rates. We thought that was a major policy mistake and we still believe the federal funds rate is above our sense of where the neutral rate is.
The second major policy issue involves China. The Chinese reversed course; they'd been stimulating quite aggressively in 2015-2016 and they switched back to focusing on deleveraging. They controlled shadow bank lending, the credit impulse went negative in 2017 and started to really fall sharply in 2018. Even now M1 growth is low. Producer Price Inflation is back below zero.
And the third factor, of course, is the trade war. The trade war has fostered a lack of confidence among business, it's created disruptions in global supply chains and has generally undermined or created a lot of business uncertainty, which manifests mostly in manufacturing and trade.
Q: We’ve had other slowdowns since the 2008-2009 crisis, but those didn’t escalate into a full-blown recession. Why is there so much concern this time around?
Q: So this time around we’ve had another plunge in global yields, the Fed has retreated from last year’s hawkishness, and other related other policy changes. Isn’t that enough to reverse the current trajectory in the global economy?
And based on current data, the LEI could actually go negative as early as this month, August. And if we look at the Federal Reserve of New York's probability of recession indicator, which is derived from the yield curve, that has now reached a level which in the past has coincided with an economic recession.
Secondly, the Chinese have undertaken a lot of policy initiatives, including the combined influence on the credit impulse and property sales, which are the primary conduit through which Chinese savings make their way into the Chinese economy.
And the third factor of course which has weighed on global growth this time around has been the trade war. There's been no improvement, there's been only escalation. The most recent escalation came on August 1st with President Trump's tweet that an additional 300 billion dollars of Chinese imports would be targeted with a 10 percent tariff on September 1st. That was followed by the U.S. Treasury Department designating China as a currency manipulator a few days later. All of this has conjured up the impression of an all out trade war reminiscent of the Smoot-Hawley tarrifs, which played out in the 1930s and which many financial historians believe contributed to the Great Depression of that era.
Q: Where do things currently stand?
If we look at the price of copper, an industrial commodity which has done a pretty good job of tracking the ebb and flow of the global economy it's back to where it was in 2016.
If we look at the break even inflation rates in the United States they're breaking to new lows. If we look at the global bond market, bond yields have plunged in recent weeks. Some of that in response to President Trump's latest tweets, which have escalated the trade war but more generally the global bond market is reacting in sympathy with the global economic cycle.
If we want to expect to see stabilization of global bond yields, we need to start to look for stabilization in the global economic cycle. We're at a fork in the road – we either get enough policy stimulus to pave the way for slow but sustainable economic growth and a global soft landing or we don't. And if we don’t, we get something worse – a global economic recession.
Q: How does this affect your outlook for global markets and the economy?
So, for the moment we're on the same page. Our expectation is there's going to be a significant amount of stimulus come through the pipeline over the course of the next six to nine months; that'll be enough to achieve a soft landing. That’ what seems to be the view embedded in in asset prices as well, judging from the U.S. money market curve and the recent breakout of the price of gold.
So if we look at a number of objective indicators there's clearly an interest rate easing cycle that has started around the world. In countries like Brazil, India, Thailand, parts of Latin America, Australia, and New Zealand there have already been cuts in interest rates. The Federal Reserve has cut interest rates by 25 basis points. As I've already said we expect more to come. The European Central Bank is preparing a large package of extra stimulus. We've got the People's Bank of China as well as the Bank of Japan making public statements about new stimulus measures.
If we look at global M0 and M1 one measured in U.S. dollars, there’s clearly been an inflection.
In general, China's approach to stimulus has been successive approximation via selective measures. They still have tremendous firepower available to them if they wish to take additional steps.
[On the trade front, the latest iteration was when the White House announced that some portion of the 300 billion Chinese imports that had been designated for a 10 percent tariffs in September might be deferred until later in December, while at the same time announcing new negotiations.]
In the United States we know that the White House is very sensitive to what happens in the stock market and the economic outlook. And we know that the odds of President Trump being re-elected in the November 2020 elections would be a lot lower if the economy is in a recession or in bad shape.
Our base case is that we think enough policy stimulus is going to come through between now and early 2020 to produce a global soft-slow-but a global soft landing for the end of the year.
Credit Impulse is defined as the change in new credit issued as a percent of gross domestic product (GDP).
Shadow banking refers to financial intermediaries involved in facilitating the creation of credit across the global financial system, but whose members are not subject to regulatory oversight.
M0 and M1 are measures of the supply of money in an economy. Each country’s central bank may use its own definitions of what constitutes money for its purposes. M0 often refers to the amount of physical cash (bills, coins), while M1 includes M0 along with checking account balances. Both are also called narrow money.
The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.
The federal funds rate (fed funds rate, fed funds target rate or intended federal funds rate) is a target interest rate that is set by the FOMC for implementing U.S. monetary policies. It is the interest rate that banks with excess reserves at a U.S. Federal Reserve district bank charge other banks that need overnight loans.
Purchasing Managers Indexes (PMI) measure the manufacturing and services sectors in an economy, based on survey data collected from a representative panel of manufacturing and services firms. PMI greater than 50 indicated economic expansion; below 50, contraction.
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