Economic Insights: A global perspective
It’s happening all over the globe: a slowdown in economic growth. The chance of a recession is still minor, but the U.S. is not immune.
Global economy slows further, but recession fears overblown
Further loss of economic momentum spread around the globe during the first quarter of 2019. Due to this slowing, global economic growth should fall below 3 percent for the year. Although that would register below growth rates from the previous two years, growth remains strong enough to withstand the loss of momentum. Weakening appears a bit more durable than previously perceived, with the slowdown carrying forward from last year into this year. First quarter could likely be the softest patch in 2019, but growth thus far has disappointed. Nonetheless, the prospect of further significant slowing in the global economy in the short term looks limited, which should prevent the economy from backsliding into a recession this year.
Synchronized acceleration across countries, which broke down in 2018, appears to have downshifted to synchronized deceleration. Across both advanced economies and emerging economies, signs of cooling seem ubiquitous. Even in countries with prospects for accelerating growth this year, those prospects have dimmed in recent months. Significant widespread forces such as deteriorating business and consumer sentiment, heightened geopolitical risk, and declining international trade volumes should weigh on growth across many countries this year.
Growth looks sluggish to start the year though it should rebound during the middle two quarters.
In the U.S., the ongoing economic expansion nears 10 years. At 10 years, the dot-com boom of the 1990s holds the current record for longest expansionary period in U.S. history. In July, the current expansion will become the record holder. Last year real GDP growth surged to 2.9 percent, matching 2015 for the strongest growth rate during the current expansion. But the largest economy in the world faces a moderation in growth as fiscal stimulus, in the form of tax cuts and increased government spending, fades. Growth looks sluggish to start the year though it should rebound during the middle two quarters. That would match a pattern seen frequently in the U.S. economy during the last 10 years – slow growth to start the year, followed by a ramping up during the second and third quarters, before falling back in the fourth quarter. Policy remains a focus in the outlook for the U.S. In addition to the loss of fiscal policy stimulus, monetary policy tightened throughout 2018 while trade policy creates headwinds for growth with the U.S. consumer paying for U.S. tariffs.
In China, the world’s second-largest economy, growth is also slowing, but not dramatically. While concerns about the veracity of China’s economic data persist, the trend matters more than the absolute growth rate. Growth should fall into the low 6-percent range in 2019, down from a projected 6.6 percent last year. Such a rate of growth would be the slowest for China since 1990 and represent a significant slowdown from last decade when growth routinely reached double digits. Increasingly, economic data show signs of this slowdown: retail sales, fixed investment, trade volumes and industrial output all point to a loss of momentum. The ongoing trade dispute with the U.S. only exacerbates the underlying trend. The federal government’s recent fiscal and monetary policy stimulus reflects their concerns about a slowing economy.
Major economies in Asia continue to diverge. Growth in Japan for 2019 continues to look subdued, due to both the cyclical slowing around the world and powerful structural changes from demographics. Japan is liquidating excess inventories which recently reached high levels relative to sales. That puts a damper on domestic industrial production. Concurrently, the financial system suffers from two key issues. With negative interest rates, banks have little incentive to lend and take credit risk because depositors pay banks to hold their funds. Meanwhile, with the population contracting, fewer people take out loans. The combination results in excessive reverses in banks that sit on balance sheets and do not circulate through and stimulate the economy. In India, growth has looked solid, partially due to moving past the demonetization that impacted the economy negatively in 2017. But also because of fiscal stimulus from the federal government as well as monetary stimulus in the form of a recent rate cut from the Reserve Bank of India. Private investment growth and declining trade volumes remain valid concerns, but India still looks to be the fastest-growing large economy in 2019.
In Europe, major Eurozone economies such as Germany, France and Italy are all struggling to various degrees. In Germany, industrial production continued to look weak during the first quarter. Weakening demand from China impacts Germany due to its reliance on exports for economic growth. Economic growth should slow toward 1 percent in 2019. In Italy, growth continued to falter in early 2019 after hitting a rough patch late last year. Italy is likely headed for zero growth, if not a technical recession, in 2019. In France, growth also continues to slow, though only modestly. Political risk remains the key in France. The government implemented some fiscal stimulus in the form of spending, and cancelled or postponed important reforms, to placate the “gilets jaunes” (yellow vests) protests. But the protests continue, further risking the outlook for growth in 2019. In the U.K., the situation hinges to a large extent on Brexit, which remains a murky proposition at best. The real economy has performed better than many had anticipated under the shadow of Brexit, particularly the tight labor market. But the exact impact of Brexit has weighed some on financial markets.
The major Latin American economies, Brazil and Mexico, should have relatively healthy growth rates in 2019. In Brazil, growth looks set to accelerate in 2019 toward 2 percent, with the economy still rebounding from a strong contraction in 2017. In Mexico, growth is expected to slow slightly, but also clock in near 2 percent. International trade and issues concerning the border with the U.S. present risks, but growth continues to hold up nonetheless.
The Federal Reserve continued to back down from planned rate hikes, signaling no more were likely in 2019.
Global yields reflect economic concerns
Monetary conditions generally loosened in the first quarter with bond yields around the world declining while yield curves generally flattened. In the U.S., the yield curve, measured by the difference between 10-year Treasury yields and 3-month Treasury yields, inverted for the first time since before the Great Recession. The Federal Reserve continued to back down from planned rate hikes, signaling no more were likely in 2019. That ends the divergence of the last few years with the Fed generally tightening monetary policy through rate hikes and quantitative tightening while most other major central banks around the world remained in a relatively loose stance on monetary policy. In Germany 10-year yields turned negative for the first time in three years due to a loss of confidence in the economy. The European Central Bank (ECB) looks unlikely to make any moves in the near-term, which leaves rates at incredibly low levels despite signs of economic weakening. The Bank of England will likely wait on Brexit before making any firm moves, though the volatility in yields could accompany decisions surrounding the timing and nature of Brexit. And the Bank of Japan looks unlikely to do much of anything. The major thread running through all these locations and central banks is that growth and inflation remain relatively weak, in some cases weaker than anticipated, which enables them to remain patient in setting monetary policy.
The U.S. dollar remains strong as investors continue to view the U.S. as the harbor in almost every tempest.
Implications for the U.S.
A slowing global environment, though not ideal, does not spell doom for the U.S. economy. Yet an integrated global economy means that linkages between economies matter. Exports represent roughly only 12 percent of GDP, but this figure has increased over time, quietly indicating greater importance to the U.S. economy. Exports also represent more than 40 percent of S&P 500 revenues, so slowing exports could pose problems for earnings if the global economy slows too much. Despite the Fed walking back more rate increases, the U.S. dollar remains strong as investors continue to view the U.S. as the harbor in almost every tempest. A stronger dollar, coupled with slowing demand from outside the U.S., makes for a challenging export environment.
The tipping point for the inverted yield curve, weakening German industrial data, showed that what happens around the world influences the situation at home. If we continue to see greater slowing around the world than we currently anticipate, that will undoubtedly reverberate through our financial markets and ultimately the real economy. For now, we remain cautiously optimistic on the global economy, but concede that the risks to our outlook continue to line up on the downside.
For commercial real estate (CRE), which depends so heavily on local factors, the global outlook appears to have little impact. But global demand still impacts the sector in meaningful ways. Large users of space across the country increasingly depend on global revenues. Any faltering could alter business plans, including their space needs. Foreign users of space in the U.S. could see their business plans, including space needs, imperiled by trouble somewhere else in the world. So far we see little fallout in the CRE sector in the U.S., but are increasingly paying attention to events elsewhere for signs of trouble.
For the CRE capital markets, which depend to no small extent on changes in interest rates, reverberations through global capital markets can ultimately wash up on CRE’s shores. Thus far, demand for CRE in the U.S. from foreign investment remains relatively healthy with cap rates hovering near historically low levels across property types and geographies. And the impact on mortgage rates seems muted thus far. But with foreign capital playing a larger role over time, particularly in certain property types (like industrial and apartments) and certain markets (such as secondary markets), issues centered elsewhere in the global economy could increasingly reverberate through domestic CRE markets.