As the end of the year looms closer, Jim McCormick, Global Head of Desk Strategy, outlines three evolving macro themes for the months ahead. Putting the spotlight on the political and economic backdrop, he looks at the implications of these themes on global growth and markets broadly.
Risks in the UK and Europe are receding
It may not seem immediately obvious, but we see risks across the UK and Europe receding.
For politics, you need to look no further than the UK, where through all the recent noise, the main message for us is that risks of a no-deal Brexit are starting to decline. And in fact, for the first time, a Brexit deal passing through parliament is a plausible outcome. If not, then a general election later this year or in early 2020 should provide some much needed clarity around the Brexit process.
Fiscal stimulus is coming
In terms of economics, we turn to the eurozone where it looks more and more likely that Germany will deliver a sizeable level of fiscal stimulus (an increase in government spending) in 2020. And this is something we’ve been expecting for quite some time now. As you can see in chart 1, we estimate that fiscal stimulus will reach levels close to 1% of GDP (gross domestic product) in both Germany and the Netherlands, averaging out at 0.5% for the eurozone as a whole. That’s the top end of our expectations and well above the consensus view.
The surprising thing is that this has barely been reported on, and in terms of our clients – it continues to be something many are highly sceptical about. But if it happens, this level of fiscal stimulus will provide a big cushion to growth across the eurozone in 2020.
Euro area fiscal stimulus projected in 2020 (% of GDP)
Source: Draft Budget Plans, EC. Based on changes to projected cyclically adjusted primary balances
A new dimension of US uncertainty
One thing does remain clear: US economic risks are rising. To start, data coming out of the US has been decidedly more mixed in recent months, with outright weakness in exports and broader manufacturing (see chart 2). Next year’s presidential election will just prove to add a new dimension of uncertainty. We know that election years are always volatile for financial markets and next year is unlikely to be an exception.
US export weakness is spilling over to the rest of the economy
Source: NWM, Haver, Bloomberg
Expect more US interest rate cuts
Given the presidential election backdrop, we now see the US Federal Reserve (the Fed) cutting interest rates once again when they meet on 30 October – the third cut in three straight meetings.
In fact, we expect this trend to continue and anticipate that there will be another three interest rate cuts by the middle of next year. Our expectations are much more aggressive than the commentary coming directly from the Fed themselves, and even more aggressive than the market. The key message on the US is that the period of economic exceptionalism is coming to an end and markets have not yet adjusted to that.
A first since 2013: Emerging markets PMIs are above developed markets
Our final theme for the months ahead takes us away from developed economies and over to the emerging markets, which have been quietly outperforming in recent months. To see this, you need look no further than manufacturing PMIs (chart 3) where the emerging market survey is above the developed market equivalent, for the first time since 2013. There are lots of reasons for this but a key component is China, where early stimulus is now feeding into the economy and providing some much-needed stabilisation.
The emerging market manufacturing cycle is above the DM cycle for the first time since 2013
Source: Haver, Markit, NWM
What does all this mean for global growth and markets? A shift, not a decline
So what does all this mean for global growth? Well today’s market landscape simply sees a little more bad news in the US and a little less bad news across the rest of the world. The bottom line is that the bad news cycle isn’t getting any worse, but it really isn’t getting any better either – it’s just shifting.
And for markets?
In our view, there are three key takeaways for markets in the coming months:
- Declining risks in Europe are likely to see German bond yields rise higher
- A more aggressive interest rate cutting cycle from the US Federal Reserve should mean lower US bond yields and a steeper US bond curve
- And finally, this relative shift in the bad news cycle toward the US and away from the rest of the world – should eventually mean a lower US dollar. We’ve already seen some US dollar weakness against emerging market currencies; we’d expect to see broader US dollar weakness heading into 2020