MANULIFE Asset Management global chief economist Megan E. Greene foresees three key issues taking centre stage this year.
In her outlook piece Growing together while splitting apart, Greene says economic growth in most major economies is set to slow in a synchronised fashion in 2019, a reversal of the near-harmonious growth the world saw two years ago.
Secondly, over the near term, equity markets are likely to be the biggest threat to growth in the United States, not monetary tightening.
Thirdly, over the longer term, the US-China trade war remains a concern: The odds of escalation outweigh the likelihood of de-escalation.
Greene notes that in late 2017, inboxes everywhere were inundated with outlooks heralding 2018 as the year of global synchronised growth. The same message about synchronisation holds true for 2019, minus the rosy fanfare.
“While 2018 was initially characterised by growth accelerating globally, I believe 2019 will involve most major economies slowing down. It will be a synchronisation all the same, but toward potential gross domestic product (GDP) which is quite a lot lower than the growth we saw in 2018. In the meantime, political risks abound and could affect economies significantly as international and national unity frays, dragging on trade and investment and causing volatility in some regions,” says Greene.
She adds that calls for a recession in 2020 are too bearish.
In a recent press conference, US Federal Reserve chairman Jerome Powell declared: “There’s really no reason to think that this cycle can’t continue for some time, effectively indefinitely.”
This business cycle is already the second longest on record for the United States, and there’s a growing consensus among economists that it will finally end in 2020.
“When economists come to agreement on when the next recession will hit, you can usually bet the contraction won’t fall that year. I’ve never been accused of being a bull when it comes to the US economy, but I think calls for a recession in 2020 are too bearish,” she says.
Greene adds that many economists are focusing on 2020 because the United States faces a fiscal cliff at the end of 2019 when the benefits of tax cuts and increased federal spending dwindle.
While a divided Congress means any additional fiscal boost heading into an election year will be politically difficult, both parties may agree on additional infrastructure spending, which could breathe new life into the economy and extend the recovery. A failure to re-up fiscal stimulus should be a headwind to growth, but needn’t tip the United States into recession.
Another interesting point she makes is that for many, the biggest threat to the economic recovery in the country and globally is the Fed.
Beginning in 2019, global central bank liquidity is set to shrink for the first time since quantitative easing began, led by the Fed, given its interest-rate hikes and balance sheet shrinkage.
She says ten of the past 13 Fed rate hike cycles have ended in a US recession. The central bank will tighten its policy too far, too fast in order to head off inflation, the story goes, and kill the expansion.
“I don’t really buy this argument. The Fed is more likely to slow down its rate of normalisation of monetary policy than hasten it. Powell suggested as much in November when he indicated that rates were just below the range of estimates for the neutral rate. We think the Fed will have to adopt a more dovish stance for two main reasons,” says Greene.
Her reasonings are such:
First, the US housing market had softened significantly in late-2018 and is likely to continue to do so because of rising mortgage rates, supply constraints and tax code changes.
On top of this, the government is likely to find agreement on reducing the price of drugs. Shelter and medical costs are two of the heaviest weights in the inflation basket, and so we expect inflation to soften.
“Second, I believe the Fed doesn’t want to invert the yield curve for fear of the signal this would send about an impending recession. With the yield curve remaining flat, the Fed doesn’t have much room to hike at the short end,” she says.
If there’s an immediate danger to the US economy, Greene feels it would be the equity markets.
“Corporate earnings tend to slow late cycle, and they could be further compressed by trade wars as price increases can’t be entirely passed on to consumers for fear of losing market share. S&P 500 Index earnings for the third quarter were up 25.0%, but analysts expect this to shrink to just 6.9% in the second quarter of 2019. If share prices stagnate or fall, it could crimp investment and confidence, slowing consumer spending,” she points out.
Her conclusion is that there will be a synchronised slowdown globally in 2019.
She feels that this should come as no surprise as growth in most countries was well above potential GDP growth in 2018. In the absence of a huge jump in productivity growth or the labor supply, economic growth should converge with potential GDP growth.
While there are some endogenous threats to growth in the United States, most potential headwinds to global growth derive from political divisions that affect economies and markets, particularly the trade war between Washington and Beijing.