February 2019 Economic Update – “Shifting Stance”

At the end of 2018, and more evident now, was a change in momentum in the global economy. This change was particularly evident in Europe and it was also evident in China. Growth in international trading volumes has been faltering in response to the US initiated tariff war. While the US and China are starting to talk about how to end the trade war, the longer it takes to find an agreement the greater the downside risk to global growth prospects.

RBA Governor, Philip Lowe noted “Some slowing in global growth was expected, given that labour markets are fairly tight and the policy tightening in the United States was aimed at achieving a more sustainable growth rate. So, I have been a little surprised at some of the reaction to the lowering of forecasts for global growth, which has been quite negative. We need to remember that the IMF’s central forecast is still for the global economy to expand by 3.5 per cent in 2019 and by 3.6 per cent in 2020. If achieved, these would be reasonable outcomes and not too different from the recent past.”

There has been an accumulation of downside risks, many of which are related to political developments such as the US/China trade war and Brexit. The modest slowing in annual GDP growth rates in the world’s key economies and concerns this could continue through 2019 are likely to slow or halt the normalisation of monetary policy settings by the world’s key central banks. The US Fed blinked first (or possibly succumbed to Trumps Twitter beating) and has decided to review and pause its plan for more hikes. However, as the chart below shows, employment is getting tight which may force wages to accelerate and lead to a jump in inflation. Inflation has remained under control thus far assisted by a sharp drop in oil prices…..now reversing.

The ECB has quickly followed suit, while China has been on an easing bias for some time this is now exacerbated by the trade war. The RBA made a strange move with its policy statement remining largely unchanged only to be followed by a speech by Philip Lowe that gave clear indication of a shift in policy direction. “Looking forward, there are scenarios where the next move in the cash rate is up and other scenarios where it is down. Over the past year, the next-move-is-up scenarios were more likely than the next-move-is-down scenarios. Today, the probabilities appear to be more evenly balanced.”

In the US there has been a softening in some indicators. Preliminary consumer sentiment fell, ISM purchasing manager reports for both manufacturing and non-manufacturing fell sharply all-be-it still in strong expansionary territory. December home sales also fell. This is set against a backdrop of record low jobless claims. The US economy still has growth momentum despite Trumps Government shut down.

In China the main leading indicators were down and there was a marked pull-back in export growth as expected from the higher import tariffs imposed by the US. This should smooth out from the prior period that was pre-loaded before the tariffs hit. China can ease monetary policy further and boost budget spending, but the drift lower in GDP growth is unlikely to be arrested without a trade agreement with the US.

In Europe, the reduction in the pace of economic growth is pronounced. Protests in France and the failure of Britain to strike a deal to exit the EU are taking a heavy toll on business and consumer sentiment. Unemployment has however continued to fall, and ECB has provided relief by allowing the growth accommodating monetary conditions to persist for a little longer.

In Australia there has been more muted effects. Housing indicators have been weak and most economic indicators point to a moderation in the pace of growth. Unemployment remains low and provides support to the consumer, jobs growth is likely accelerating on the back of increasing commodity prices and Government infrastructure spending. These factors have outweighed the negative impacts of the US/China trade war although Brazilian miner, Vale, has helped with one of its dams bursting. This catastrophe has led to some 70mt of seaborne iron ore to be taken off the market creating a short-term iron ore squeeze and windfall for Australian terms of trade and government budget coffers.

Throughout January and February, share markets have recovered, led by the shifting stance of central bankers. The US/China trade war and uncertain Brexit outcome continue to weigh on GDP growth. It is difficult to predict the outcome of either of these two critical events, but it seems neither issue will be magically resolved by their respective deadlines. It is more likely that both issues will continue to cause markets to sing from optimism to pessimism through the year. Central bankers may lean towards a neutral stance but tightening employment markets and rising oil prices may see inflation move into target range causing central bankers to shift stance yet again.

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This information was prepared by Royston Capital, ABN 98 158 028 392 AFSL 438262. The information in this presentation is current as at 18 February 2019 unless otherwise stated.

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Sources: Admiral Investments, Alexander Funds Management (Steven Roberts); Commbank Global Markets Research, Morningstar.d