The global economy is in good shape, with an early estimate for growth in Gross Domestic Product (GDP) in the second quarter of 2018, at 3.5%, on an annualised basis. This is despite the lingering threat of a trade war and political instability.
Economic data for the US continues to signal that their economy is on a firm footing. In the second quarter of 2018, US GDP grew on an annualised basis, 4.1%, which is the fastest growth in nearly 4 years. Both consumer spending and business investment have boosted the US economy.
In July, the NFIB (National Federation of Independent Business) Small Business Optimism Index, which is a survey of small independent businesses, reached 107.9, the second highest in its history and just 0.1 below the record high, set in 1983. The survey suggests that businesses are increasingly optimistic about future sales and improving conditions for business activity.
Whilst it is clear that businesses are benefiting from the strength of the US economy, as well as fiscal tailwinds, the high levels of optimism suggest the economy is at the top of the economic cycle.
The UK economy also produced stronger economic data, with GDP in the second quarter of 2018 growing, quarter-on-quarter, 0.4%, up from a rate of 0.2% in the previous quarter. The economy benefited from the warmer weather, which boosted retail sales, and the construction industry.
In the three months to June, UK unemployment declined 65,000 to 1.36 million. The unemployment rate, at 4%, is at its lowest level for more than 40 years.
The stronger economic news followed the Bank of England (BoE) raising interest rates, from 0.5% to 0.75%. This is the highest level since the financial crisis a decade ago. The BoE Governor, Mark Carney, said further rate rises would be “limited and gradual”. BoE Monetary Policy Committee member, Ian McCafferty, also commented that the UK could expect “another couple (of interest rate rises) in the next 18 months to two years”. He explained that higher interest rates would give the BoE room to cut interest rates, if the economy hits a difficult patch.
The Eurozone economy has weakened in the second quarter of 2018, with GDP growing, quarter-on-quarter, by just 0.3%. This is a slowdown from 0.4% in the first quarter of the year and from 0.7%, in the fourth quarter of last year. However, the German economy has set aside fears over a global trade war, picking up pace in the second quarter, growing 0.5%, which beat market expectations of 0.3%.
The Japanese economy has returned to growth and has avoided a recession. In the second quarter of 2018, GDP rose 1.9%, year-on-year, which contrasts to a first quarter contraction of 0.9%. The Japanese policymakers have announced that they will make no change to their quantitative easing programme. The Bank of Japan has recently updated its economic projections and now expects the economy to expand between 1.3% and 1.5%, in the 2018 fiscal year, which ends in March 2019. The economic data suggest the Japanese economy is weathering the labour shortages and fears of a global trade war.
US/China trade war
The US/China trade war has started to affect the Chinese economy. The services sector saw a notable slowdown in July, as business confidence fell to a near record low. The China Caixin-Market Services Purchasing Managers’ Index fell to 52.8 from 53.9.
Although in June, China’s trade surplus with the US hit record levels, in July, China’s trade surplus with the US dropped slightly to $28 billion, as tariffs started to be felt. Chinese exports to the US fell 2.5%, while imports declined by 1.5%.
The US is negotiating with China, although no agreement has yet been reached. The market consensus is that the US President, Donald Trump, will declare victory against China shortly before the US Mid-Term elections, and before any material damage to global growth prospects.
The US has also imposed sanctions on Turkey in a dispute over the arrest of a US pastor; however, Turkey’s problems are primarily a monetary policy crisis that has spilled over into currency and fiscal policy. Turkish inflation, as measured by the Consumer Price Index, has risen from 11.92%, year-on-year, at the beginning of the year, to 15.85%, year-on-year, at the end of July 2018. The Turkish Central Bank has failed to control inflation and has kept the official base rate at 17.75%. The risk to the global economy and markets is one of contagion.
Many emerging market countries have seen their currencies weaken, in sympathy to the problems in Turkey. Not all emerging markets have similar structural fragilities, however, those that do include South Africa, Argentina, Russia and Indonesia. The problems in Turkey are unlikely to impact the emerging markets, as a whole.
One potential problem, however, could be the amount of Turkish debt owed to European banks in that it is estimated that French, Italian and Spanish banks have debts of around $139 billion. It is too soon to say whether this is going to be a serious issue.
The US economy is continuing to drive the global economy, but it is becoming clear that their economy is at (or very near) the top of its economic cycle and that monetary policy is in the process of being ‘normalised’, i.e. interest rates are expected to rise to more normal levels. The key risks to the US, as well as the global economy, are the US Federal Reserve raising interest rates at too fast a pace and an escalation of the US/China trade war.
Although the Turkey crisis is unlikely to lead to a global economic crisis, the fact that Donald Trump instigated sanctions for what is a relatively minor diplomatic dispute, illustrates that he will, if desired, escalate the US/China trade dispute. Nevertheless, at this stage the consensus is that the dispute will be resolved before the US Mid-Term elections.