The last few weeks have been an eventful time for the global equity markets, with a sharp correction. Equity markets were led lower by the US, due to concerns the US Federal Reserve (Fed) will raise interest rates at too fast a pace, leading to an increase in borrowing costs and, thereby, hurting the global economy.
The global economy and global trade
There are signs that global economic growth is beginning to slow down, with the International Monetary Fund (IMF) downgrading their 2018 and 2019 global growth forecasts by 0.2%. The IMF is forecasting that the global economy will grow 3.75% in both 2018 and 2019. The IMF noted that trade tensions between the US and its trading partners have started to hit economic activity. The IMF’s chief economist, Maurice Obstfeld, stated that earlier projections appear to be “over optimistic” given the risks from “further disruptions in trade polices”. Maurice Obstfeld also commentated that two major regional arrangements are in a state of flux – NAFTA (North America Free Trade Agreement) and the EU (European Union). NAFTA has a new trilateral agreement that awaits legislative approval, whilst the EU is negotiating the terms of Brexit.
US tariffs on China are also a key risk to the global economy. The IMF has maintained that the US and China will grow by 2.9% and 6.6% respectively, in 2018, but expects that both will slow more than expected to 2.5% and 6.2% respectively, in 2019.
The emerging and developing markets have seen larger cuts to their IMF growth forecasts. Maurice Obstfeld said, “Broadly speaking we see signs of lower investment and manufacturing, coupled with weaker trade growth”. The downward revisions were notable in several countries, namely, Argentina, Brazil, Mexico, Iran and Turkey.
The IMF has also cut its forecasts for global trade volumes. The total goods and services flow is expected to grow by 4.2% in 2018 and 4% in 2019. This is down 0.6% and 0.5% respectively, from earlier estimates.
The US economy is still making positive progress, with unemployment declining to 3.7% in September 2018, from 3.9% in each of the previous two months. This was below market expectations of 3.8% and is the lowest jobless rate since December 1969. In previous economic cycles, a jobs market that has been so strong for so long usually results in the labour market taking more capital from corporate profits. So far, this has not been the case, but there are signs wage growth is beginning to surface. In September, average hourly earnings increased, on an annual basis, by 2.8%, easing from a 2.9% rise on an annual basis in August, which was the highest annual gain since June 2009.
The Fed has increased US interest rates for a third time so far in 2018, bringing the target rate to 2 – 2.25%. Interest rates are expected to rise one final time this year, in December. The Fed also dropped reference to an “accommodative” policy as it reduces the economic stimulus it put in place during the financial crisis. The Fed is still indicating there will be three interest rate increases in 2019 and another in 2020.
The uncertainty of the Brexit negotiations are impacting the UK economy, however, on the positive, the UK unemployment rate has remained unchanged at 4% in the 3 months to August, the lowest level since 1975. UK workers’ total earnings, excluding bonuses, increased by an annual 3.1% in the 3 months to August 2018.
The European Central Bank (ECB) President, Mario Draghi, has delivered an upbeat assessment of the region’s economy, stating that the ECB would continue to phase out quantitative easing as planned, ending the bond buying programme in December.
The Brexit negotiations are not the only political risk for the EU. Italy’s new government are in dispute with the EU over their proposed budget that plans to increase the country’s deficit to 2.4% of annual economic output in 2019.
Italy’s coalition want the fiscal policy to make good on pre-election pledges. The EU has rejected the plan, citing Italy’s huge debt pile. The dispute has sent the yield spread between Italian and German 10-year bonds to the highest level since 2013. The uncertainty has led two of the three credit ratings agencies, S&P and Moody, to downgrade Italy’s sovereign credit rating. The ratings downgrade tells investors that it has become riskier to lend money to the Italian government and, therefore, it has led to a sell-off in the Italian government bond market. The ratings downgrade is putting pressure on the Italian government to reverse their proposed budget. The EU/Italian dispute has lowered the chances of the ECB increasing interest rates in September 2019.
China’s economic slowdown
China’s economy is showing signs that it is slowing down and confirms the trends identified by the IMF. China’s GDP for the third quarter (July to September) grew 6.5% from a year earlier, but this was below market expectations of 6.6%. Although the quarterly expansion remains healthy, it is the slowest quarterly expansion since the first quarter of 2009. China faces rising economic challenges, including high debt levels and the intensifying trade dispute with the US.
Although the global economy is showing signs of slowing down, there are still indicators of robust economic growth, which are being reflected in corporate earnings, particularly in the US. However, the economic and political risks (such as the Fed increasing US interest rates at too fast a pace and the threat of a full-scale US/China trade war) that could derail the global economy, are beginning to affect the current economic figures and forecasts.