Global economic outlook: Trade war not the only fly in the ointment
Economic Quarterly Report
- The outlook for the global economy has become less rosy, and the downside risks have increased
- World trade is clearly slowing
- We expect a recession in the US at the end of 2020, and that the US central bank will cut interest rates once in 2019 and five times in 2020
- We expect moderate growth in the eurozone
- We also expect the trade war between the US and China to rumble on for some time yet
- Emerging markets continue to be exposed to external factors such as rising geopolitical tensions and an escalation of the trade war between the US and China. However, a few countries could actually benefit from this
Economic outlook increasingly less rosy
We are slightly downgrading our economic forecasts for the global economy. Currently, we expect to see global GDP grow by 3.3 percent this year and next. This is a 0.2 and 0.1 percentage points lower respectively for these two years than the forecast in our last Quarterly Report. Because of a good first quarter this year, we expect to see slightly higher growth in the United States (US), France, Spain and the United Kingdom (UK), while growth in the eurozone, Japan and emerging markets such as China, India and Brazil will grow by less than previously expected (table 1, figure 1). The slower growth in the global economy in 2020 will be broad-based, and the risks to the current picture have increased rather than declined. There is therefore a real possibility that the prospects for next year could soon become less positive if the risks we see materialize. The main downside risks for the global economy are a further escalation of the trade war between the US and China, a sharper than expected slowdown in Chinese growth, a deeper recession in the US in 2020 than we have currently priced in, a disorderly Brexit, and tensions in the eurozone in relation to Italy (for more on the last two points, see the section on the eurozone).
Global trade growth is declining, even without an escalation of the trade conflict
The weaker global economic growth is clearly showing in the sharp slowing of the volume of world trade. The slower growth of world trade is broad-based, but particularly noticeable in the eurozone and China. If the trade war between the US and China escalates, world trade will come under further pressure in the coming period.
Risk of a US recession still as serious as ever
For the US, the world’s largest economy, we still expect to see a recession. As we have mentioned before, a good measure to gauge the likelihood of a US recession is the difference between the 12-month and 10-year yields on US government bonds. This measure currently indicates that the likelihood of a recession in the fourth quarter of 2020 is higher than 80 percent.
There are increasing signs of economic weakness in the US on other fronts as well. Based on the ISM purchasing managers’ index (ISM PMI), we expect to see further weakening in US industrial production in the coming period (figure 3). In addition, the most recent jobs figure shows that there were only 27,000 jobs added in the private sector in May, the lowest growth in nine years. Finally, investment in housing has fallen for five consecutive quarters. Declining investment in housing has previously been a good indicator that the US economy is on its last legs. Against this background of economic weakness, lower than expected inflation and increased risks of a trade war, the US central bank (the Federal Reserve Bank, or ‘Fed’), has publicly mentioned the possibility of an interest-rate cut for the first time. In 2019, we expect the Fed to make one “insurance cut” of 25 basis points, followed by five cuts of 25 basis points each in 2020.
 Industrial production recovered in May. Since this featured strong growth in production by utility companies, the rebound was probably due to non-recurring factors such as the weather.
Does this spell trouble for emerging markets?
It is not yet clear how the expected change of direction by the Fed will affect emerging markets. Lower US interest rates as a result of a looser monetary policy by the Fed will mean that returns on US assets will be lower, prompting investors to look elsewhere for higher returns. Emerging markets generally benefit significantly from such a development. The positive effect could however not be enough to offset the greater global economic and political risks. Investors will in this case put up with a lower return and seek refuge in safe haven assets, meaning that outflows of capital from emerging markets will quickly accelerate. Emerging markets with current account deficits, a budget deficit and relatively high levels of debt in foreign currency are especially vulnerable to external shocks. These include Argentina, Brazil, South Africa and Turkey. These countries are forced to raise foreign capital in order to finance their deficits. In addition, geopolitical tensions, for instance between oil-producing countries, could cause volatility in oil prices. This could lead to more volatility in exchange rates and inflation in emerging markets.
A tweet does more harm than good?
The trade war between the US and China has flared up again. On the evening of Sunday, May 5th, President Trump tweeted that the US would increase the 10 percent import tariffs previously imposed on USD 200 billion of imports from China to 25 percent, due to the breakdown of trade negotiations. Shortly thereafter, on May 10th, words turned into deeds and the higher US tariffs took effect. In retaliation, China increased tariffs on June 1st (between 10 and 25 percent) on USD 60 billion of imports from the US (see figure 4). Trump additionally threatened to impose tariffs on virtually all imports from China, which would make a further USD 287 billion of Chinese goods subject to higher tariffs (see figure 4).
Attention is now turning to the G20 summit to be held in Osaka on June 28th and 29th. There is a chance that a meeting between Presidents Trump and Xi Jinping at the G20 could again lead to a truce, but the most recent signs suggest that this is a remote possibility. Indeed, we have always believed that a deal would not last for long, simply because both superpowers are miles apart on more structural issues. Based on the current situation, the chance of further escalation would seem to be increasing, with more damaging economic effects as a result (Box 1).
The US wants a solution to structural issues that it objects to, such as the violation of intellectual property rights by China, compulsory transfer of technology by foreign companies doing business in China and exorbitant subsidies to Chinese state owned entities from the Chinese government. Chinese leaders do not want to make such commitments as this would breach China’s sovereignty. In addition, they are unable to meet some agreements. If the Asian superpower removes its support for inefficient state owned entities at a rapid pace and opens its markets to foreign competition, it is highly likely that these state owned entities will not survive.
More than tariffs alone
What is being referred to as a trade war is actually being fought on an increasing number of fronts. The US has blacklisted Huawei, the pride of China in the high-tech industry. This makes it very difficult for US suppliers to supply this company, and a number of significant companies have already ceased to do so: Broadcom, Qualcomm, Xilinx, NXP and Google.
In our trade war scenario study, we argue that this constitutes the greatest risk for China. Imports of US intermediate goods and thus US technology are still of existential importance for the Chinese economy. The US has now cut this lifeline, and further measures cannot be ruled out. China is currently also looking at its options for retaliation. There is much speculation as to whether China could use supplies of rare earth minerals to exert pressure. These rare earths are used for applications in the high-tech industry, for instance in mobile phones, lasers and defense material. China provided 80% of these rare earths to the US between 2014 and 2017.
Box 1: Further escalation of the trade war will lead to a downgrade of estimates
Our current estimates are based on the most recent developments in the trade conflict between China and the US. This means that we see further escalation as a realistic scenario, but we will adjust our estimates once the situation becomes more clear. The volatility of this bilateral conflict has shown us that a degree of caution is appropriate.
Our most recent update shows that current global economic growth is estimated cumulatively to be 0.7 of a percentage point lower as a result of the measures already in place. In case of full escalation, this would rise cumulatively to 2 percentage points. For the US, the damage would be 0.9 of a percentage point and 1.6 percentage points respectively. China would be expected to suffer the most, with the cumulative decline in growth rising from 1.5 percentage points under the current measures to more than 5.7 percentage points in case of further escalation. All these scenarios are in comparison to the benchmark scenario of no trade war.
There are also aspects of the trade war for which we do not currently have enough information. For instance, the trade war could disrupt internationally integrated value chains. One third of the value added by the US consists of foreign intermediate goods, and 5 percentage points of this comes from China. The higher tariffs will also increase costs for users of intermediate goods, which will be either at the expense of their profits or passed on to end users.
Another factor that could worsen the situation for China is that US and European companies are making arrangements to transfer their operations to low-wage countries such as Vietnam and India as a result of the increased uncertainty related to the trade war. The effects of this are already visible in Vietnam, in the exports of Vietnamese goods to the US, which rose by 40 percent in the first four months of 2019 (compared to the same period in 2018). Other South-East Asian countries could also benefit in certain sectors, for example Malaysia in semi-conductors.