Authored by Morgan Stanley’s chief economist, Chetan Ahya
Trade tensions between the US and China have been the single biggest source of uncertainty for the global economy over the past 18 months. After a protracted period of negotiations, some progress has been made towards a deal, with a potential Phase 1 to be signed in mid-November. How much of a difference will this make for the global economy?
To start with, we estimate that trade tensions and their impact on corporate confidence and capex have cost the global economy about 90-100bp of growth momentum. Studies by the Fed staff and the IMF suggest a similar impact. Global growth has decelerated close to a post-crisis low of 2.9%Y in 3Q19 from its peak of 4.1%Y in 1Q18.
Second, trade tensions have renewed the structural risk of secular stagnation. As we’ve highlighted before, the global capex cycle has essentially ground to a halt since mid-2018, when tensions emerged. Just as it seemed that years of policy support had finally restored the capex cycle in 2017-1H18, trade tensions have snuffed this recovery out. A capex revival is the key to lifting the global economy out of a stagnation-like environment.
Some might argue that the role of trade tensions in shaping the global outlook has diminished now that central banks are back in the business of providing monetary accommodation. We’ve noted that 20 central banks globally are now easing, and there’s more in the pipeline. By early 2020, the weighted average global monetary policy rate will be tracking fairly close to post-crisis lows. Nevertheless, we think that trade tensions will still determine how early and how strong the recovery will be.
If the current pause turns out to be durable, we believe that the global economy can recover from 1Q20. It’s likely that global consumer spending would improve, and corporate confidence would stabilise. However, we’re sceptical that businesses will resume capex spending in the near term, considering the fall-off in demand and declining utilisation ratios. Moreover, despite recent progress in trade negotiations, the way forward to signing Phase 1 remains somewhat ambiguous. While further tariff increases have been suspended for now, there is no immediate plan to roll back the existing tariffs. The deal is also being structured in phases, leaving us some distance away from the comprehensive agreement that we think is a prerequisite for a robust recovery. In short, uncertainty is likely to linger for a while, leading us to expect only a weak recovery, to still below-trend growth.
If tariffs should rise on December 15, we would expect weakness in global growth to continue for the next two quarters (4Q19/1Q20). We also think that a further increase in tariffs could increase the risk of non-linearity kicking in. The corporate sector could abandon any hope of a recovery and start firing workers, a decision they have not taken so far. Should this scenario unfold, it would overwhelm the effects of the monetary easing now under way, triggering a much deeper slowdown and raising global recession risks significantly.
In sum, trade tensions still matter a great deal to the outlook for the global economy. In the four weeks until the proposed APEC meeting between the two presidents, we will watch the commentary and progress in negotiations closely (particularly the draft agreement) to assess if a durable pause materialises.