Monthly Macro Outlook: The great stabilisation
Summary: The market narrative has shifted to economic stabilisation, but short-term risks to growth remain and we are still skeptical about the ability of stronger central bank liquidity to revive growth in 2020.
Over the past few months, the market narrative has shifted to economic stabilisation as central banks have massively stepped in in order to stimulate economic activity. Based on our calculations, more than 60% of central banks are easing globally, which is the highest level since the GFC. Many investors especially attribute the market’s rise to the Fed’s repo actions and the continued talks between China and the United States to reach a trade agreement. We even see more and more market participants talking about the potential for a rotation back to cyclicals and emerging market trades. However, in our view, short-term risks to growth remain and we would like to see a more clearly weakening USD before moving back to EM. We remain skeptical about the ability of higher central bank liquidity to revive growth in 2020 which means that fiscal push will be needed to stimulate the current business cycle.
China: wait-and-see position
In Asia, one of the most important news of the past months is that our leading indicator for the Chinese economy, credit impulse, is about to turn positive for the first time since Q4 2017. It is currently running at minus 0.4% of GDP. As China roughly represents 1/3 of global growth impulse, we could see the constructive global ripple effects of positive credit push in 2020. However, contrary to previous periods of slowdown (2008-2010, 2012-2014 and 2016), the global impact of positive China credit push is expected to be much more limited due to the following three reasons:
- Credit impulse transmission is not working as efficiently as in the past because many domestic banks are saddled with bad debts;
- Credit intensity has considerably increased over the past years. Before 2008, the country needed on average one unit of credit to create one unit of GDP. Since the GFC, 2½ units of credit are required to create one unit of GDP. It means that injecting more credit in the economy is not the miracle solution it used to be;
- The disadvantages of credit push (more debt and heavy private sector debt service ratio) tend to surpass the advantages (lower rates and higher liquidity).
On the top of that, the process of financial deleveraging has not been completely abandoned by the authorities. If we use as a proxy for deleveraging the evolution of loans to non-banking financial institutions, we see a strong jump in loans on YoY basis in 2018, at the height of the trade war, followed by a return of the deleveraging process from mid-2019 (total loans to non-banking financial institutions are out at minus 8.4% YoY in October). Except for some marginal adjustments, like it has happened in November with the cut of interest rate on the one-year MLF loans, we expect that the PBoC will be in wait-and-see position until the end of the year and much of the first part of 2020.
Rest of the world: All eyes on Germany
In Europe, economic weakness persists. We see the euro area growth close to zero in Q4 2019 on a Q/Q basis. What worries us the most is the growing divergence between countries that are resilient to ongoing headwinds (France, Spain and Portugal) and countries that are facing both cyclical and structural issues (notably Germany). Over the past few days, there have been signs that the German economy may have bottomed out. The country avoided falling into technical recession in Q3 due to a rebound in external demand from the United Kingdom and Turkey, and the latest consumer confidence survey tends to point out that willingness to spend is still high.
However, we think that the worst has yet to come for Germany. On the cyclical side, the country is still negatively impacted by China’s slowdown, which is its most important trade partner with a total trade volume of around 200 billion euros. The latest data show that Germany export growth to China is still contracting, at minus 8.2% YoY in October and, based on preliminary data, it could get worse in coming month and lead to a new fall in Germany’s manufacturing PMI in December or January.
On the structural side, we notice a deterioration of the quality of GDP, as government spending offsets investment and domestic demand, which underlines lower confidence from the business sector. We also notice that Germany has still not addressed the issue of misallocation of R&D investment. While Germany is well-ranked in terms of R&D investment, 50% of this goes into the struggling automotive sector, resulting in a chronic underinvestment in the ICT sector. It largely explains why Germany is lagging behind Asia/China in new innovative industries. It would be exaggerated to state that the country is the new sick man of Europe, but it is obvious that Europe’s traditional locomotive is down and will not be able to catch up with past economic performances anytime soon.
In the United States, we don’t think there is a strong case for recession in 2020. Most US leading indicators are pointing out to growth deceleration and are not in recessionary territory yet. The most commented leading indicator, the Leading Economic Index (LEI) published by the Conference Board, decelerated to a growth rate of 0% in October. It is bright clear that the US industrial cycle is in downturn mode. US manufacturing, known as an efficient coincident indicator of the industrial earnings cycle, is in contraction at 48.3 in October versus an annual peak at 56.6 in past January. The recent slight rebound (from 47.8 to 48.3) should not be overstated as trade war impact and China’s low growth remain.
However, economic activity should keep being supported by personal consumption, as was the case in Q1 and Q2 of this year. Personal consumption has been the most important contributor to GDP growth since the beginning of the year and the trend should continue in coming quarters. Government spending, which has been low, may increase if the slowdown is deeper than anticipated. The only worrying spot is related to fixed investment which has been a drag on GDP growth since January and is not expected to rebound anytime soon due to high CEO pessimism. Overall, our view for the US economy is neither bad nor good. We forecast that US growth will move towards 1.6% next year, that inflation will be contained, and that unemployment will stay below 4%.
Calendar of December 2019
Dec 5: OPEP meeting and Aramco stock pricing
Dec 6: OPEP+ meeting and US NFP
Dec 9: Rumored to be the day of the announcement of Saudi Arabia’s budget
Dec 11: FOMC meeting and first day of trading for Aramco stocks
Dec 12: SNB/ECB meetings and UK general election
Dec 19: BoE meeting