International economic agencies such as the OECD continue to downgrade their global economic growth forecasts, reflecting downside risks to growth from the entrenched US/ China trade war as well as areas of political turbulence including Europe, the Middle East and Hong Kong/China. The global growth forecast downgrades are occurring despite a near concerted effort by the world’s central banks to lower official interest rates and prime liquidity despite evidence that the economic numbers in the US, still the world’s biggest economy, have mostly beaten market expectations over the past month. On the negative side, international trade numbers are mostly weak in many countries (Australia is an exception to this trend), contributing to weaker growth in China and has pushed Germany close to recession. All told the economic outlook is mixed and confused by political risks, causing businesses in many countries to be more cautious before committing to invest. Central banks are likely to continue adding monetary stimulus, however at some point Governments are likely to spend more as well to alleviate the risk of a slide in to recession from a world where the impulse to invest is weak while the imperative to save seems to be gaining momentum.
In the US, household spending growth remains strongly underpinned by decade-high annual increases in wages (average hourly earnings up 3.2% y-o-y in August); low unemployment and rising household wealth. Retail sales rose by 0.4% m-o-m in August after increasing 0.8% in July setting the scene for another strong contribution from household spending to GDP growth in Q3. Housing investment is likely to be another strong contributor to Q3 GDP growth. Almost every US housing indicator released in September has comfortably beaten market expectations. The September National Association of Homebuilders’ index lifted to 68 from 66 in August. August readings of existing home sales; new home sales; and pending home sales were up m-o-m respectively 1.3%; 7.1%; and 2.5%. August housing permits and starts were up respectively 7.7% and 12.3% m-o-m. The strength of housing and retail spending in the US make it highly unlikely that the US economy will slide into recession in the near-term. Instead it is likely that Q3 GDP growth will match or beat the 2.0% annualised growth recorded in Q2.
Nevertheless, there are parts of the US economy that are showing signs of weakness, mostly the parts connected to international trade or international investment. The August manufacturing ISM purchasing managers index slipped to 49.1, below the 50 expansion-contraction line although still well above readings that in the past have signaled recession. The continuing tariff war between the US and China is showing few signs early resolution with President Trump’s erratic tweets swinging between signs of trade-negotiation progress and threat of a long, escalating trade conflict adding to business uncertainty and cutting into business investment spending plans.
The parts of the US economy that are internationally facing and directly impacted by the trade war are small relative to household demand, limiting the likelihood of the US economy falling into recession although a slow erosion of US growth is possible. The Federal Reserve (Fed) has started responding to the risk of fading US growth by delivering two 25bps rate cuts this year, the latest cut occurring earlier this month. The Fed has termed the rate cuts as “mid-cycle” adjustments implying that there will be only one or two more rate cuts ahead, potentially reducing the Funds Rate from the current 2.00% to 1.50% early next year.
China, with greater dependence on international trade to support growth is showing more evidence of slowing than the US. Q2 GDP growth slowed to 6.2% y-o-y from 6.4% in Q1 and the signs are that China’s economic growth rate is slowing further in Q3 (GDP due mid-October) possibly below 6.0% y-o-y. August readings mostly showed signs of slowing growth. Exports slipped to -1.0% y-o-y from 3.3% in July. Annual growth moderated in August in the key areas of industrial production, 4.4% y-o-y from 4.8% in July; fixed asset investment spending, 5.5% y-o-y from 5.7% in July; and retail sales, 7.5% y-o-y from 7.6% in July. The Peoples’ Bank of China responded to signs of weakening growth with reductions in both bank reserve ratio requirements and official interest rates. Complicating the outlook for China’s economy are the continuing pro-democracy protests in Hong Kong and an anti-pollution drive in key heavy manufacturing regions, reducing output ahead of and during this weeks’ 70th birthday celebrations of the founding of the Peoples’ Republic of China. While China is expected to ramp up government spending to try and promote growth, there has been no indication of such a change so far. The longer China goes relying mostly on monetary stimulus and a weaker exchange rate to counter the trade-driven moderation in GDP growth, the greater the risk of more pronounced slowing.
In Europe, a prospective hard British Brexit remains a high probability as hopes of a negotiated exit flounders amid British Prime Minister Boris Johnson’s attempts to bluster through to the October 31st exit deadline. The British opposition parties are reluctant to go to an election without Prime Minister Johnson first delivering either an extension of Brexit negotiating time or a new and acceptable exit deal with the EU, which is seemingly impossible. A hard Brexit will lead to a recession in Britain and weaker growth in the EU where GDP growth was barely running above 1% y-o-y in Q2 and the biggest European economy, Germany is at imminent risk of sliding into recession. Unsurprisingly, the European Central Bank at its September policy meeting announced a reduction in its deposit rate by 10bps to -0.50% and a return to buying bonds (QE) from banks to boost liquidity. In his final ECB policy meeting, President Mario Draghi called for European governments to provide greater fiscal stimulus to reinforce monetary stimulus in policy efforts to lift growth.
In Australia, the signs of moderate-paced economic growth generating good growth in employment but no reduction in the unemployment rate and no upward pressure on inflation continued in September. Q2 GDP rose 0.5% q-o-q after an upwardly revised 0.5% gain in Q1. While year-on-year GDP growth slipped to a decade-low 1.4% in Q2, annualised GDP growth in the first half of 2019 at 2.0% was stronger than the 0.8% annualised growth in the second half of 2018. Much of the improvement in growth in the first half of 2019, however, was down to unusually strong government spending and a marked lift in exports which could be hard to sustain.
The soft parts of the Australian economy remain to be household consumption spending and residential construction spending. While home buying activity and house prices are now rising, this will take time to halt the slide in residential construction, particularly in the over-supplied new home unit market. Tax cuts may help to lift household consumption spending in the near-term, although slow growth in wages continues to weigh. While employment growth remains strong (up over 30,000 in both July and August) the number of people joining the labour force is rising even faster, causing the unemployment rate to drift upwards from a cycle low point of 4.9% in January this year to 5.3% in August.
The upward drift in the unemployment rate is a sign of increasing excess capacity in the labour market threatening to halt the slow improvement in annual wages growth. Annual inflation on all measures is lodged around 1.6% y-o-y or lower and is unlikely to rise into the Reserve Bank’s 2-3% target band over the next year. The RBA has cut the cash rate twice in June and July to a record low 1.00% and stands ready to cut further to support improvement in economic growth prospects even though it is becoming less clear what further monetary policy easing may achieve. One important monetary policy transmission mechanism, however, remains impact on the Australian dollar exchange rate, helping to prevent unwanted appreciation of the currency in a world where other central banks are lowering interest rates. The RBA looks set to cut the cash rate again this week by 25bps to 0.75% and may follow up with a further rate cut early in 2020.