The year 2019 opens on a less confident note as we look out upon slowing economic growth worldwide. This time last year, by contrast, we were contemplating a backdrop of increasing momentum.
For the first half of 2018, that momentum played out in a synchronised trend across most of the global economy. By the second half of 2018, however, the cracks began to appear as this expansion – while persisting overall – became more divergent. In particular, the US remained robust while other economic regions, including Europe and Japan, started to fall behind. The split was increasingly clear in currencies and interest rates, too, with the dollar continuing to strengthen and the Federal Reserve pushing ahead with rate rises while other central banks held back.
While most major economies continued to expand up to the year’s end, leading indicators increasingly pointed to growth slowing across the piece – including in the US. Our latest estimates suggest that US growth will have peaked in the third quarter of 2018 at 3.2%, and we expect it to fall to 2.5% in the final three months. This slowdown is set to extend into 2019 and beyond (see graph, below).
In Japan and Europe, growth in the second half was disappointing for a number of reasons. Japan suffered a slew of natural disasters, including earthquakes, floods and heatwaves, which took their toll. In Europe, new car emission rules interrupted normal production and sales in that significant industry. As a result, Germany’s economy shrank by 0.2% in the third quarter, falling from 0.5% growth in the three preceding months. Although data was not available at the time of writing, Germany was expected to have returned to growth by the end of 2018, but the overall message is one of fading growth.
Equity markets, having enjoyed a summer of gains, took fright in the fourth quarter. Some of the volatility stemmed from the ongoing antagonism between the US and China over trade and tariffs, but as the year drew to a close fears increasingly focused on weakening US and global growth and changing monetary conditions.
In early December, a key investor indicator signalled a warning for the US economy. The “yield curve” describes the shape of the graph depicting the returns available on government bonds, which in a typical market are higher for bonds with longer maturities. When the yield curve “inverts”, as happened in the first week of December, it is a sign that the market anticipates a slowdown.
US real Bond yield^ vs shape of the US yield curve*
^US 10 UST yield minus CPI *Term premium as indicated by the difference between the yield from 10-year UST and 2-year UST
This indicator has been a precursor to the majority of past recessions, and hence has significant influence over market sentiment.
What lies ahead
We now expect declining growth in 2019, with the global economy growing 2.9% (2018: 3.3%). The US will continue to grow at a higher rate than other economic regions, but we expect US growth to decline from 2.9% in 2018 to 2.4%. The Eurozone, Japan and the UK are expected to grow by under 2%.
In the US, President Trump has criticised the Federal Reserve’s successive rate rises, saying “I don’t like what they are doing”, and declaring the tightening policy poses a “bigger problem than China”.
We expect US rates to reach 3% by mid-2019, and potentially reduce thereafter as activity slows. In Europe, which is behind the US in terms of a return to interest rate “normalisation”, we expect rate increases in the second half of 2019 and possibly into 2020. Political risks remain present on a number of fronts. We think disputes between the US and China over trade and tariffs will continue, with the negative consequence of pushing up prices while negatively impacting growth.
In Europe, where political risk is a more or less permanent feature, there are danger spots in Italy and elsewhere. Disputes between Italy’s populist government and the EU over public spending continue to shine a light on the Eurozone’s inherent vulnerabilities. France is facing its own troubles in the form of disruptive anti-Macron protests by the “gilets jaunes”.
Brexit continues to cast uncertainty over the outlook for the UK from a political and economic viewpoint. UK assets are likely to underperform until some clear outcome emerges.