Forecasts: Third Quarter 2019 - Growth Moderates, but Expansion Continues

The world economy has swung from a synchronized global upturn that saw global GDP growth accelerate to a six-year high of 3.8% in 2017 to a synchronized global slowdown set to reduce growth to a post-crisis low of 3.3% this year. The shift may appear drastic seen from this perspective, but the reality is that we had been inching this way for some time. Indeed, compared to three months ago, our estimates of 2019 and 2020 global growth have only been reduced by 0.1 percentage point (ppt) each, to 3.3% and 3.4%, respectively. The downgrades largely reflect the materialization of risks on the trade front, with additional escalation of tariffs relative to what we anticipated earlier in the year. More so than the tariffs implemented thus far, the breakdown of trade negotiations between China and the US in early May fueled expectations of further escalation and fears of a broadening dispute (as exemplified by Huawei). This, in turn, not only exacerbated the already sharp slowdown in global trade — mirrored in a simi ar pullback in global industrial production — but also undermined business sentiment and caused the capex cycle to fizzle out. Half way through the year, while the possibility of a trade deal is still alive, the reality is that more damage has been done to the global economy and any subsequent healing will take longer to materialize. Therefore, what had earlier looked to be a brief and shallow deceleration has taken on a more permanent hue.

Global inflation forecasts were also only minimally altered, but where changes were made, they were to bring estimates down. The key message remains that the much talked about inflation “deficit” persists across developed markets despite continued labor market healing that has brought unemployment rates to multi-decade lows. Having highlighted the inflation “mystery” a couple of years ago, the Federal Reserve (Fed) alongside other central banks, has engaged in a more focused review of concepts such as NAIRU (non-accelerating-inflation rate of unemployment) and the neutral interest rate. From the Fed to the Bank of Canada to the Reserve Bank of Australia, there is clearly greater openness to the idea that NAIRU may be quite a bit lower than previously thought, the implication being that central banks can afford to let economies run “hot” without risking an inflation event. And yet, it would be incorrect to assume that inflation is altogether dead; rather, we view it as “manageable”.

Changing central banks’ views around NAIRU and the neutral rate help reconcile what might otherwise be viewed as an apparent contradiction in the evolution of our macro forecasts. Indeed, whereas growth and inflation forecasts were little changed, expectations about the monetary policy stance associated with these new forecasts changed meaningfully. In a sense, our biggest challenge this time around was trying to reconcile incoming macro data that, while signaling a slowdown, remains inconsistent with a recession, and current market expectations (and even central bank signals) of meaningful easing that seem better aligned with just such a recession scenario. Ultimately, we chose to acknowledge the seemingly changing reaction function of central banks while still calibrating the response in terms of the number of rate cuts incorporated in our central forecast. While a desire to “extend the cycle” is commendable, doing so by deploying monetary easing at a juncture which may not allow a subsequent unwind of such cuts before the next recession hits may leave central banks with less, rather than more, policy space at that future point.