Global growth is no longer making headway

You can spin it any way you want: the global economy is weakening. Marc-Antoine Collard, Chief Economist and Director of Economic Research at Rothschild& Co Asset Management, outlines the way forward.

Central banks have decided to (re)introduce monetary easing measures in the face of significant political risks and rising trade tensions. These measures have reassured equity investors, who are hoping that this will halt the global growth slowdown.

However, the continued appreciation of the U.S. dollar, the collapse of global policy rates and the sharp reversal of the U.S. yield curve cast doubt on the effectiveness of the expected monetary easing, especially because central banks' ability to act is limited. With a U.S. president whose economic and geostrategic actions have become increasingly unpredictable, downward revisions to global growth continue. This is now about to happen in the U.S. itself, although some market participants had predicted a decoupling from the global economic cycle.

The trade dispute continues to escalate

Although it is in both countries' interest to find a lasting solution, the U.S.-China trade war has escalated. Since the 1. September, the Trump administration is imposing tariffs of 15% on a portion of the remaining $300 billion. U.S. dollars in imports from China that had previously been spared. From the 1. October, tariffs on goods worth 250 billion. US dollar to be raised from 25% to 30%. By the end of 2019, Chinese goods worth around 540 billion euros will have been sold. U.S. dollar, with the 15. December is scheduled for a final collection of tariffs. These measures have severely damaged business confidence. President Trump nevertheless continues to ignore the many warnings of possible negative economic effects, preferring to blame the Fed for everything.

Currently, representatives of China and the U.S. are busy agreeing on the schedule for a planned meeting. So far, it appears that no real progress has been made on the thorny issues of technology transfer and subsidies for Chinese state-owned enterprises. Although its own economy is slowing, China is showing little flexibility and refusing to give in. Authorities plan to provide more support to the economy, including investment in infrastructure projects and regional development. Although China has been trying to stabilize its economy for more than a year or. even to boost the economy, no convincing results have been achieved.

While some room for maneuver remains, investors may be disappointed with the effectiveness and scope of the support measures. The Chinese economy still faces high debt, shadow banking regulation and environmental constraints that should not be underestimated.

Financial stability at risk in emerging markets

Meanwhile, the yuan depreciated again against the dollar, posting its worst month since China's currency reform in 1994. Devaluation is not without risk, as it could weigh on domestic demand and increase capital outflow risks, while foreign exchange reserves are relatively lower than before. More broadly, the devaluation will also affect other emerging markets, putting financial stability at risk.

In addition, another trade war broke out in the region, between Japan and South Korea. The two countries saw an intensification of their trade disputes after South Korean courts demanded compensation from Japanese companies for South Koreans forced to work in factories during the Japanese occupation. Although the direct impact of protectionist measures remains difficult to assess, collateral damage is being felt in both countries, which are already suffering from the U.S.-China trade war and the global economic slowdown.

Sluggish economy in the euro zone

Unfortunately, the deteriorating international environment is not sparing the eurozone either. Economic activity was sluggish in the second quarter of 2019, recording growth of just 0.2%. Italian growth stagnated, while German GDP declined by 0.1%. France only modestly exceeded expectations with growth of 0.3%; only Spain is doing relatively well at 0.5%. Supported by a still strong labor market – the unemployment rate was 7.5% in July (lowest level since 2008) – market participants expect the euro zone to improve in the second half of the year. In addition, business confidence in the service sector remains strong and decoupled from the impending recession in the industrial sector.

The political situation in Italy also seems to have calmed down: The new coalition of the 5-Star Movement and the Democratic Party is much closer to Brussels and EU regulations, which has led to a drop in Italian government bond interest rates.

Aggravated slump in the industrial sector

However, the two parties have yet to agree on the political agenda, and the 2020 budget remains a major challenge. The new government does not plan to implement the previously targeted VAT increase. The resulting shortfall of around 23 billion. Euro is to be compensated for by a reduction in expenditure and/or an increase in other sources of revenue. At the same time, German factory orders fell again in July by 2.7%, exacerbating the slump in the industrial sector. Retail sales also recorded a decline of 2.2%.

Given the ongoing international trade conflicts and weak business expectations, especially in the manufacturing sector, no fundamental improvement in momentum is in sight in the coming months. Accordingly, the economic outlook for export-oriented Germany remains uncertain. The Bundesbank has warned that GDP could contract in the third quarter of 2019, which by definition leads to a technical recession (two consecutive quarters of declining output).

Brexit: outcome remains unpredictable

In the meantime, British Prime Minister Boris Johnson is sticking to the Brexit and has asked Parliament of 11. September to 14. October into a forced recess. This significantly shortens the time MPs have to take action against the government. The growing chance of an early election is not in itself a guarantee that the situation will improve. The polls point to a Conservative majority government led by a prime minister who keeps repeating that the UK will leave the EU on 31. October will be left with or without an agreement.

In summary, the outcome of Brexit is unpredictable, leading to a devaluation of the British pound and a decline in business as well as consumer confidence.