As has become normal in recent months, interpreting macro data is quite challenging. To follow the abundant amounts of data every day and develop a macro thesis is like building a jigsaw puzzle that is continuously changing its shapes. If this is normally already difficult, in the last few months this has become especially complex, with key data giving contradictory signals, strong revisions and various exceptional elements. The behavior of the markets adds more doubt to an already complex macroeconomic environment, leaving the burden of proof on the continuity of the cycle in the second half of the year.
Despite all this confusion, we don’t expect a substantial improvement in the growth rate. In Fidentiis Gestión – Global Strategy, we expect a stabilization in 2Q19 below potential, which will give way to a stagnation in which the risk of recession increases, with world growth at about 3% for 2019 (US 1.5%, EA 0.7%, China 6.1%).
The main cause of this changing pace of the world economy is the weakness of the manufacturing sector. The expected recovery of activity in 1Q19 has not occurred and has continued to deteriorate. China, for the first time in many years, lowered their expected growth to 6% -6.5%, the bottom part of their target range. In the Eurozone, the revision of expected rates was even more aggressive, falling from 2% to close to 1%. In the US, despite the weakness reflected in 1Q19 data, growth estimates remain around 2.3%.
The shift in central bank policies will allow a stabilization of growth in 2Q19. The change in the Fed’s bias at the beginning of the year was decisive in reversing the financial contraction at the end of the year and urged other central banks to implement a new round of stimulus policies. Markets have discounted at the end of the US rate hike cycle and returns in Europe have Japanized. The expectation that trade disputes will be resolved and the dwindling probability of a hard Brexit help to dispel political uncertainty. Finally, Chinese stimulus policies will reverse the weak performance of recent quarters.
However, we believe that it will be difficult to see a sustained improvement towards growth rates nearing potential for the following reasons:
We aren’t seeing a recovery in the manufacturing sector. The advanced components remain negative and anticipate weakness in 2Q19 (new orders, export orders and expectations continue to dwindle). This will continue to exert downward pressure on industrial production, investment and employment. By historical patterns, the manufacturing sector will normally have an impact on the service sector.
The US, the most robust economy and the main driver of demand will slow down notably and we see a downward risk in growth estimates. Regardless of the more or less positive sentiment around the American economic cycle, there is no doubt that growth rates will slip from 3.1% to slightly above 2% according to consensus.
The goal of the Chinese government is to stabilize the economy at around 6%, not start an acceleration that will significantly boost global economic growth.
The symptoms of chronic stagnation are once again visible, with the euphoria of reflation already forgotten. Negative real rates, expectations of low inflation, stunted productivity, falling investment and anemic growth, validate the hypothesis of secular stagnation.
The pause in the rate hikes and the end of the FED QT and the ECB TLTRO are not additional stimulus measures to boost the economy, but rather represent pause signal to stabilize financial conditions.
The resolution of political risks will continue to be subject to uncertainties: a China – US trade agreement will probably focus on the EU, the prolonging of Brexit will continue delaying investment decisions and the European electoral wave may give surprises. The absence of geopolitical risks is always the exception, but in a context of low growth its impact is amplified.
A new adjustment in financial conditions, even lower than that of 4Q18, will lead us into a recession. The markets will discount a mid-cycle pause or «goldilocks» scenario. If the arguments of this thesis (acceleration of European and Chinese growth and a soft-landing in the US) are again put into question in the face of further deterioration in the fundamental metrics, we believe that the market reaction will be just as violent as that of the end of 2018. The narrow margin in fiscal and monetary policy magnifies this mechanism of transmission to the real economy. We will not find large imbalances that justify a recession, but the capricious change in risk appetite can be a definining factor.
Jorge Nuño
Gestor del fondo Fidentiis Global Strategy de Fidentiis Gestión