The first Q3 GDP reports indicate that global economic growth is losing momentum. International economic agencies such as the IMF have downgraded global growth prospects for 2019 and 2020 to around 3%, the slowest pace since the global financial crisis. The weakness in growth is mostly in export and manufacturing sectors, as well as business investment spending weighed by political and economic risks. The world’s central banks are mostly easing monetary conditions to stimulate more spending, but are calling for their efforts to be reinforced by more government spending. Political uncertainty relating to the US/China tariff war and Brexit became less pronounced in October, with some prospect of a trade war truce developing between the US and China. There are also hopes that the latest Brexit deal between British Prime Minister Boris Johnson and The EU may get through the British Parliament with an extension of the Brexit 31st October deadline to allow fuller parliamentary consideration of the deal. Evidence that the pace of global growth has moderated that in earlier months might have ratified recession fears, has been mitigated through October by signs that political headwinds to growth are easing and policy makers stand a reasonable chance of delivering a soft economic landing rather than recession.
In the US, the first look at Q3 GDP is due this week and is expected to show moderation in annualised growth to around 1.6% from 2.0% in Q2. Housing investment and household spending are likely to make strong contributions to growth in Q3, much as they did in Q2. That strength is likely to be part offset by negative contributions to growth from business investment spending and exports running more powerfully than in Q2. Looking beyond Q3 there are reasons to expect a turn to stronger US GDP growth. Housing activity is gathering momentum helped by very low mortgage rates and evidenced by the September National Association of Homebuilders’ Index pushing up again to 72 from 68 in September. Wages growth remains strong at 2.9% y-o-y in September and the unemployment rate fell in September to 3.5%; a 50-year low. Household spending and housing accounting for more than 65% of spending in the US economy looks set to continue growing strongly.
More importantly, some of the factors causing weakness in US exports, manufacturing and business investment spending look set to fade. The US/China tariff war is unlikely to get worse and hopes are firming of a truce and eventually a bi-lateral trade deal. The Federal Reserve has cut the funds rate twice so far and has indicated that it may do more to help the US economy through what it terms mid-cycle growth softness. It has become clearer that the Fed is trying to engineer a soft-landing for the US economy and the US bond market has become more accepting of the Fed’s message, pushing up longer-term bond yields relative to short-term bond yields and changing the shape of the bond yield curve from inverse mid-year (a harbinger of recession) to positively shaped, more consistent with a growing economy. The Fed is expected to cut the funds rate another 25bps this week to 1.75%.
China’s economy has been damaged by the tariff war with the US. Annual GDP growth slipped a little more than expected to 6.0% y-o-y in Q3 from 6.2% in Q2. September economic readings showed weakness in international trade with exports down by 3.2% y-o-y and imports down by 8.5% y-o-y, both worse than expected outcomes. Other September readings were mixed strength with fixed asset investment spending up 5.4% y-o-y, a touch softer than 5.5% reported in August; industrial production up 5.8% y-o-y, a marked improvement on 4.4% y-o-y reported in August; and retail sales up 7.8% y-o-y from 7.5% in August. Hope of a trade truce, if realized, will help lift China’s growth prospects, but it is more likely that the authorities will press ahead with monetary and fiscal measures to ensure the slide in China’s annual GDP growth rate is arrested. Political unrest in Hong Kong and China’s response remains an area of uncertainty. So far China has resisted hardline intervention but if that changes the consequences would likely be negative for China’s trade and growth prospects.
In Europe, Brexit with a deal has become a stronger prospect, albeit with a further delay beyond October 31st. Europe’s economic prospects, however, remain soft. International trade friction has pushed highly export oriented Germany close to stalling point. Q3 European GDP is due later this week and it is likely that quarter-on-quarter GDP growth will be only about 0.1%, reducing annual growth to around 1.1%. International trade and manufacturing are weak in Europe (Germany’s manufacturing PMI is below 42; usually a sign of recession) but domestic demand and employment remain quite firm and inconsistent with weak GDP. The European Central Bank (ECB) remains concerned about soft European economic growth prospects. The ECB, after cutting its deposit rate 10bps to -0.50% and reintroducing QE at its September policy meeting (a decision that divided members of the ECB policy committee) left monetary policy unchanged at its October meeting.
In Australia, signs are emerging of stronger economic activity. At the fore front of the improvement is continuing evidence of a strong rebound in home sales and house prices. Housing finance commitments have risen three months in a row and while the decline in home building activity is yet to base the strength of home sales since the May Federal election and with assistance from three RBA rate cuts point to the start of an improvement in home building approvals and commencements over the next six months or so.
Another positive surprise in October came with the release of the September labour force data showing employment growth in the month, ahead of growth in labour supply edging down the unemployment rate to 5.2% from 5.3% in August. A little more tension in the labour market may help to boost annual growth in wages that have flatlined at 2.3% y-o-y this year so far. Annual growth in household disposable income has also been soft (around 3% y-o-y) but is receiving a boost from the Government’s tax cut helping to lift retail spending. Retail sales rose 0.4% m-o-m in August, one of the better gains over recent months.
Australian GDP growth in Q1 and Q2 2019 was stronger than in the second half of 2018, although almost entirely supported by strong growth contributions from net exports and government spending. Growth support from exports and government spending is likely to be less strong in Q3 and Q4 2019 but there are now signs that housing, household consumption spending and business investment spending will take up the slack. The RBA in various speeches and comments during October has shifted its comments from indicating the likelihood of more cash rate cuts in need to the economy is slowly improving, reducing the need for more rate cuts. Our view is that the base case for Australia’s growth prospects has tipped in favour of slow improvement although downside risks remain. As a result, we still pencil in one more 25bps cash rate cut to 0.50% early in 2020 although the need for another rate cut could fade if recent signs of improvement in growth prospects continue to swell.