Global Outlook – Western Asset Management
- We expect that global growth will prove to be resilient, even in the face of interconnected risks that include trade tensions, slowdowns in Europe and China, and a potential hard Brexit.
- Our estimate for US growth in 2019 is between 2.0% and 2.25%. We’re encouraged by a recent rebound in consumer spending and a tentative improvement in manufacturing data.
- We see nothing in Fed policy nor in the ongoing growth rates of nominal GDP that would suggest any inflation spikes over the near to mid term.
- For the eurozone, we recently down-graded our growth expectations to about 1.0% for 2019 given recent data prints.
- On US-China trade tensions, we do not expect to see a quick permanent turnaround in the near term as neither country appears keen to concede ground.
- In line with other DMs, growth has slowed in Australia and we now expect growth of 2.0%-2.5% in 2019.
- While oil prices over the short term are expected to be in the $55 to $62 per barrel range given the recent drone strikes in Saudi Arabia, we expect an eventual return to our $50 to $55 per barrel range.
Global growth prospects remain clouded by a number of interconnected risks: a sustained decline in global manufacturing activity due to ongoing global trade tensions, a more pronounced slowdown in Europe and China, the possibility of policy missteps by the Fed and ECB as they look to enact additional stimulus measures, and fear of an imminent hard-Brexit scenario due to political chaos and newer flashpoints in Hong Kong and Saudi Arabia, with ramifications that remain unknown at this time. While downside risks have risen this year, we believe global growth should prove to be resilient. We remain encouraged by the ongoing strength of the consumer globally and the enormous amount of monetary stimulus supplied by both developed (DM) and emerging market (EM) central banks—the combined weight of these two forces should truncate downside growth risks as we move closer to 2020. Here we provide a summary of the key drivers behind our global outlook, how we’re positioned in broad market portfolios and a more detailed description of where we see value in today’s markets.
US: Economic Growth Continues to Hold Up Well
At present, we are estimating US growth between 2.0% and 2.25% for 2019. Earlier in the year, an apparent sputter in consumer spending and income growth had caused us to reduce our forecast, but both indicators have rebounded over recent months making a low 2%-handle outcome most likely. This rebound in consumer spending and a tentative recent improvement in US manufacturing sector data make the chances of recession even lower now than they were a few months ago when we were expecting slightly slower 2019 growth. While various elements of the US economy are showing slower growth than was the case over 2017-2018, nowhere is there actual weakness or any indication of an ongoing deceleration that would raise the threat of recession.
Constant news of tariffs—and retaliatory tariffs—between the US and China have caused some to fear the downside implications of this ongoing spat for the US economy. At present, however, we see no tangible evidence that trade wars are adversely affecting US economic aggregates. If anything, the US trade balance has improved slightly relative to trend so far this year, implying a slight boost to GDP growth, rather than the drag some profess to see. Developments in capital spending by US corporations also show some recent improvement, if anything, contrary to claims that trade fears are restraining capital expenditures. While core inflation measures have also rebounded a bit in recent months, the upswing merely offsets some of the especially low inflation seen earlier in 2019. All in all, then, inflation looks to be holding below the Fed’s 2% target. We see nothing in Fed policy nor in the ongoing growth rates of nominal GDP that would suggest any meaningful upside pressure on inflation.
Europe: Growth Sturdy, Risks Rising, All Eyes on Brexit
We revise down our growth expectations for the eurozone in 2019 on the margin given recent data prints, but still believe that growth will come in around 1.0%. The slowdown in global trade has taken an outsized toll on German growth, while political risk earlier in the year is likely to have brought Italy to an economic standstill. We also view issues in the German car manufacturing and chemical industries as having contributed to the slowdown after four years of above-potential growth, but we see those hindrances becoming less important over time.
Looking ahead to 2020, we also revise our growth expectations lower somewhat on the back of recent disappointments in soft data including service PMIs, but, on aggregate, we still see a small pickup over 2019 to around 1.2% on the back of Germany and Italy doing better. We expect the German economy to accelerate next year and grow around potential, partly due to base effects and partly as the result of the supply-side constraints mentioned earlier becoming less binding. Abating political noise in Italy should be conducive to growth rebounding there as well. Other large eurozone countries, on the other hand, could slow somewhat but are likely to grow roughly at potential, supported by accommodative monetary and fiscal policies across the continent. Risks around this baseline for 2019, but especially for 2020, are skewed to the downside, in particular if the service sector weakness in soft data becomes more pronounced and starts showing up increasingly in hard data. Other key risks next year include a disorderly Brexit, higher crude prices, further trade escalation and renewed political risk in Italy.
Regarding the UK, we are of the view that the recent Supreme Court ruling has substantially reduced the chances of a “no-deal” Brexit this year as it has strengthened the role of Parliament in the process. Instead, we expect that either (1) Parliament approves a deal before October 19 that is perceived as a marginal improvement to the one negotiated by former Prime Minister Theresa May or (2) the current Prime Minister Boris Johnson—or a caretaker government—requests an extension before the end of October, followed by a general election. While the narrative keeps shifting, we are marginally more hopeful that a “deal” will come to pass before the end of October as there seems to be a more concerted effort from the UK to make meaningful proposals on how to resolve the outstanding issues around the Irish backstop.
Our 2020 growth outlook for the UK comprises, therefore, an unusually large degree of uncertainty. Inflation, similarly, depends significantly on the levels of the exchange rate and the introduction of tariffs and transaction costs, but we think that in the case of a “no-deal” Brexit, the Bank of England will look through a temporary rise in inflation and cut rates to support the economy.
China: No Quick Fix
China’s economy is slowing for both structural and cyclical reasons at a time when the global economy is softening. Facing this backdrop, Chinese policymakers have judged that giving their domestic producers breathing room with a currency devaluation makes sense. However, the key challenge for small and micro enterprises remains financing availability, as banks continue to be cautious in lending. The People’s Bank of China’s 2Q19 monetary policy report maintained continued accommodative monetary policy, though in reality it would mean more of the same, with the overarching aim of preventing further froth in property markets.
On US-China trade tensions, we do not expect to see a quick permanent turnaround in the near term, as neither the US nor China appear keen to concede ground. Seemingly intractable positions at least from a domestic political perspective look set to persist. In the extreme event of a further hardening in US stance, global markets could see further deterioration. This underpins the uncertain policy environment in developed markets, which is detrimental for investment. Looking ahead, escalating tensions and uncertainty will continue to weigh on sentiment leading to further drags on capital expenditure and consumer confidence.
Australia: Avoiding Stall Speed, For Now
Growth has slowed in Australia in line with other DMs and we now expect growth of 2.0%-2.5% in 2019. Although a reluctant cutter, the Reserve Bank of Australia (RBA) reduced rates three times since June after almost three years on the sidelines and has maintained an explicit easing bias. The market has brought forward expectations for the next rate cut, perceiving a greater likelihood of one more cut before the year-end and the possibility of further easing in 2020.
There are indications that the housing market has bottomed with a few months of rising prices after almost two years of declines. The wealth effect from a turnaround in housing may help improve the lackluster contribution to GDP growth from the consumer over the past year or so. Although very strong, jobs growth has failed to keep pace with record labour force participation over the past year, resulting in a small rise in the unemployment rate, one of the key indicators the RBA has explicitly targeted in its rate-setting deliberations. Together with the firm dovish tone from the RBA, this would point to another cut in the near term.
Oil Markets: Geopolitics Takes Center Stage
A series of drone strikes against the world’s largest petroleum processing facility in Saudi Arabia resulted in the loss of 5.7 million barrels per day of Saudi oil production. This amount represents a little more than 5% of global supply and has the potential to destabilize the oil market’s supply/demand balance. Before this event, we believed WTI oil prices were range-bound at $50 to $55 per barrel, consistent with management and industry budget setting.
From a fundamental perspective, the crude market in 2019 is considered relatively balanced—resilient oil demand growth, US production growth, OPEC and Russia’s compliance with target quotas, supply disruptions and geopolitical risk support the argument. In recent times, these factors were seen to be moderating into 2020 with concerns over trade tensions and weaker economic growth, hence demand. The Saudi event has only served to highlight the prospect that geopolitical risk may not be fully incorporated into prices and focus has returned to the region, including the Strait of Hormuz, which is a potential chokepoint.
While WTI prices over the short term are expected to be elevated in the $55 to $62 per barrel range given the supply-side impact and questions over production restoration, we could see a return to our $50 to $55 per barrel range over the medium to long term given lower demand growth from slowing forward economic activity.
The Big Picture
Developed Market Rates: Relative Value by Region
Relative Value by Sector