“The best of the current economic expansion is behind us, but it seems too early to argue that a downturn is imminent, as low inflation and loose policy could keep the recovery on track till late 2019.”
– Richard Jerram, Chief Economist, Bank of Singapore; Member of OCBC Wealth Panel
The current recovery has been unusually long and slow. By some measures, it is in its late (or final) stages but by others, it is merely mature, with plenty more to come.
For now, the global cycle looks well supported by loose policy settings over the next 12 to 18 months. However, there are some question marks as we look into 2020. Among the major economies, the US is the best candidate to see a recession, as its cycle is the most advanced and it has the added risk of tightening fiscal policy by 2020. However, even there, the risk of recession is only a possibility rather than a certainty.
Growth is still being supported by the looser fiscal policy that is blowing out the budget deficit. This is extremely unusual at such a mature stage in the cycle; government borrowing typically rises and falls with the unemployment rate, as shown in the chart.
Fiscal stimulus into a hot economy is likely to suck in imports to meet some of the additional demand, which will widen the trade deficit, even in the face of current protectionism. These twin deficits point to downwards pressure on US Dollar once interest rate expectations have adjusted to a more realistic profile.
The pace of recovery in Europe has slipped to some extent, but it is still relatively healthy. Business and consumer sentiment readings are still comfortably positive and pointing to a solid pace of expansion. Monetary policy should be gaining traction as financial health improves, while benefits from structural reforms gradually filter through, and fiscal policy is neutral and no longer a drag on growth.
Perhaps as a warning to the new government in Italy not to reverse fiscal reforms, the ECB made an earlier-than-expected announcement that its asset purchases would wind up by the end of this year, with the first rate-hike following, perhaps in 3Q 2019. It seems to be following the same path as the Fed in managing the exit from ultra-loose policy, albeit with a lag of about three years.
Tight labour markets show that the Japanese economy continues to prosper, while surprisingly good tax revenues suggest that growth might be stronger than some of the economic data indicate. Even so, inflation remains subdued, although the headline rate is being boosted by higher energy prices.
The Bank of Japan is set to remain on hold for the foreseeable future, with no realistic options for meaningful easing if the recovery stalls or the yen spikes, and no urgency to start to tighten. It will be the last major central bank to exit from the current loose policy.
The short-term need to support growth in the face of trade restrictions and barriers to technology transfer from the US seems set to interrupt longer-term efforts to reduce leverage in China’s economy. This is likely to come through cuts in the reserve requirement ratio, accompanied by fiscal stimulus.
Over the past 18 months, the credit bubble that developed after the Global Financial Crisis has stabilised, suggesting that policies to control leverage were finally gaining traction. However, credit growth is likely to pick up again, which will complicate the eventual long-term challenge of deflating the bubble without causing significant economic or financial system disruption.
Rising US interest rates present a challenge for emerging markets where an external deficit results in significant funding needs. Fortunately, this only applies to a small number of countries, led by Argentina and Turkey. The scale is not large enough to be systemic, especially as several have improved economic policy making after pressure from the “taper tantrum” of 2013.
Another current issue is that higher commodity prices help emerging markets, but there are winners and losers, especially when oil prices are strong. Rising interest rates have the potential to exacerbate the problems of the commodity importers.
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