The fact that the hard stop in Asian trade is temporary should not blind investors to weakness elsewhere. The narrative that the slowdown in the world economy has been driven by China or the trade wars and that stimulus and a US-China trade agreement can reverse it is too simplistic. In reality, weak export demand has exposed structural flaws in the Eurozone economy (and for that matter that of Japan) which make it too easy for growth to drop below the stall speed at which feedback loops generate weakness rather than strength.
Stockpiles built in anticipation of US tariffs on China rising to 25% are now being drawn down. This inventory liquidation has crashed Asian trade. The good news is that it is temporary and Asian exports should pick up in 2Q. The bad news is that this will be the last hurrah for global trade growth. The weakness in the Eurozone far exceeds the levels that can be ascribed to sluggish demand from China. Stabilisation of China’s growth is necessary for global trade to recover but it is not sufficient. US growth will slow as the Republican fiscal package drops fully from the data.
Weak Asian trade
The slowdown in Asian trade has taken world trade growth below the pace at which, historically, commodity prices have fallen, squeezing commodity exporters’ incomes. The weakness becomes self-reinforcing in 2020 as manufactured goods demand from commodity exporters dries up. This is not a world recession, but a return to the desynchronised global growth that has typified most of the post-GFC period.
Headline inflation to drop
Inflation has fallen sharply as commodity price effects from 1H18 have neutralised. We expect it to fall further as commodity prices decline in 2H19 and 2020. Headline inflation rates will drop below core. But inflation is already low enough to permit any and all central banks to reduce interest rates if growth requires it. Global bond yields are falling. This in turn makes it easier for rates to be cut in emerging markets. Rate cuts are being discounted most aggressively in the US where the growth outlook least warrants it. We expect the Fed to leave rates unchanged.
Rates heading south
As the world economy decorrelates, with the US impacted less than elsewhere, the US dollar will stay strong. Rates will be cut in an increasing number of Asian countries. But they are already low and we question the effectiveness of monetary policy. In most Asian countries, 2020 will be a slower year than 2019 and 2019 is already slower than 2018.
Weak global growth has meant that for most of the post-GFC period, disinflationary forces have dominated. They have grown quickly in the last three months. Market sentiment has shifted from worrying about tightening to discounting the first rate cuts. It is in the US markets where this is most aggressive (and the Fed has certainly done a speedy 180°). But we don’t expect US cuts to be delivered and the strong US dollar will therefore continue. However an increasing number of Asian central banks will cut rates in 2H19 and 2020. We would prefer fiscal stimulus and infrastructure
spending; rates are already low, making them lower is of questionable benefit.
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