Can commercial real estate withstand a slowing global economy paired with increasing geopolitical risk? Our quarterly global outlook has answers.
We foresee growth slowing further, to around 2.5% for 2019. That would mark the worst performance for the global economy since 2009.
Global growth continues to slow
Global economic growth continued to slow during the third quarter. After fighting against uncertainty and negative sentiment earlier in the year, real economic activity is slowly succumbing as we anticipated. While signs of trouble emerged in the first half of the year, data in the third quarter reaffirmed the downshift in growth, with further loss of economic momentum. Global risks and uncertainty loomed over the global economy, threatening growth as the year wore on. While those factors remain, declines in real activity show that potential trouble is turning into actual trouble.
We foresee growth slowing further, to around 2.5% for 2019. That would mark the worst performance for the global economy since 2009. Global economic growth has slowed (on an annualized basis) by roughly 100 basis points from its peak in late 2017 and we expect further loss of momentum in the latter half of the year. Increasingly, the risks to our outlook increasing line up on the downside. Mid-2% growth remains far enough above the stall rate that we believe the risk of a global recession remains relatively remote. But headwinds and risks remain, complicating the outlook.
The U.S.-China trade situation remains as tense as ever, with increased tariffs further weighing on growth.
Geopolitical risk heightened in 2019
Heading into the year, we believed that 2019 could pose the greatest geopolitical risk in decades. That potential has clearly come to fruition. Seemingly every week a new global risk emerges, grabbing attention away from the prior risk that transfixed households and markets. In recent weeks the drone attack on the oil infrastructure in Saudi Arabia and the U.S. administration’s interactions with Ukraine dominated headlines. But risk from earlier in the year continue. The U.S.-China trade situation remains as tense as ever, with increased tariffs further weighing on growth. Brexit remains unresolved more than three years from the referendum. And populism remains a force in virtually all regions of the world, threatening policies that are counter-productive to continued economic growth.
Monetary policy to the rescue?
With geopolitical risk starting to rein in economic growth and create downside risks, yield and bond markets continue to flash significant warning signals. The amount of sovereign debt trading at negative yields increased to roughly $17 trillion while increasing a larger number of yield curves in various countries around the world inverted. While yield curve inversion remains a better recessionary signal in the U.S. than other countries, inverted curves nonetheless signal concerns about slowing growth and the potential for economic contraction. Global central bankers are attempting to ride to the rescue and stave off further slowdowns in several regions around the world. The U.S. Federal Reserve has already cut rates twice, totaling 50 basis points (bps) and the futures market anticipates another rate cut of 25 bps in the fourth quarter. The European Central Bank (ECB) also cut rates recently (albeit slightly) and indicated that it would restart bond purchases of roughly 20 million euros per month starting in November. Other major central banks such as the Bank of Japan (BOJ) have held rates steady for now but have cautioned that cuts could come if further weakening continues. Some central banks will likely be more successful than others in their attempts to bolster their respective economies, but lower interest rates should not be taken as a panacea.
With just one quarter left in the year, the economy should head into the holiday season in relatively good health.
Slowing continues among largest economies
In the U.S., the world’s largest economy, trade tensions have soured the mood among political leaders and weakened private investment. While still growing on a year-over-year basis, private investment contracted in the second quarter, alarming many including the Federal Reserve. Corporate tax cuts (passed in late 2017) and still-low interest rates should have spurred significant investment in 2019. Yet concerns surrounding tariffs and trade policy have trumped lower taxes and cheap debt. The pullback in private investment has left consumption spending as the lone aggregate demand driver. Consumer confidence and sentiment have pulled back in recent periods but remain at elevated levels due to a still tight labor market and continued wage growth. Consumers and the labor market should remain in the spotlight – even if private investment recovers, consumption still accounts for roughly two-thirds of the economy. Any weakening in consumer spending could portend trouble ahead. But with just one quarter left in the year, the economy should head into the holiday season in relatively good health. Political risk remains a wild card with the domestic landscape still problematic.
In China, the world’s second-largest economy, activity slowed in recent periods on a broad basis. Investment activity seems restrained, net exports declined, and consumption growth decelerated. While the trade war with the U.S. is having some impact on China’s growth prospects, weak demand in other parts of the world plus a cooling demand situation at home demonstrate the slowdown stems from multiple causes. The economy remains on track for its weakest growth since 1990. While growth in China greatly exceeds that of many nations, decelerating growth there translates into a noticeable slowdown in global growth because of the economy’s size. China also must contend with its own domestic political risks in Hong Kong as well as external political risks.
Japan has become collateral damage in the trade war between the U.S. and China. Business sentiment deteriorated further in recent periods, particularly in the manufacturing sector where businesses feel the strain from trade tensions and weakening demand for exports. Additionally, the recent consumption tax hike, passed to help firm up the budget, could dampen consumer sentiment and consumption spending. The impact on the economy should remain limited, because the government should implement offsetting measures. Yet rising taxes during a period of relative weakness should not spur growth. The BOJ remains on hold for now, but the country already boasts negative-yielding debt so the impact from any potential rate cuts remains uncertain.
Economic growth has slowed considerably in India over the last year and a half, pulled downward by both consumption spending and private investment. Moreover, the economy does not appear to be rebounding despite substantial monetary policy stimulus from the Reserve Bank of India (RBI). Lower yields should help push credit to consumers and bolster consumer spending somewhat. But the economy will likely need further policy stimulus before mounting a more meaningful rebound in its growth rate.
In continental Europe, Germany has also become collateral damage in the trade war between the U.S. and China, particularly its manufacturing sector. Germany depends greatly upon exports to drive economic growth. With trade tensions and barriers at elevated levels, external demand for Germany’s goods has lessened. If external demand remains weak for an extended period, that could translate into faltering domestic demand. Consumer confidence looked a bit shaky in recent periods. In France, trade tensions negatively impacted exports and investments, but domestic consumption has held up well, bolstered by elevated confidence among both consumers and businesses.
In the U.K., Brexit remains a rather unpredictable mystery. While the October deadline remains in place, an extension could occur, delaying the issue once again. The economy contracted during the second quarter. Some firms are stockpiling inventory in anticipation of Brexit, but then unwind excessive inventories when the data gets pushed. That is causing some whiplash with growth getting an initial boost before backing off. The manufacturing sector still looks a bit weak, and growth should remain positive, but at a modest level.
Across the Americas, the Canadian rebounded strongly during the second quarter, after some weakness in the prior two quarters. Net exports offset some domestic weakness, which could mean some slowing through the end of the year. In Brazil, despite continued weakness in the real, it appears as if room remains to cut interest rates. Though growth remains weak, the economy continues to recover from a soft patch earlier in the year. In Mexico, the passage of the U.S.-Mexico-Canada Agreement (USMCA) would help bolster the economy, but the probability of passage by the end of the year seems slim, at least in the U.S.
Implications for the U.S. economy and CRE
Much of the slowdown in growth in recent periods stems from the U.S. trade tensions. Uncertain trade policy not only directly impact the U.S. economy via tariffs, but also impact it indirectly through psychology and sentiment. Political risks (particularly self-inflicted ones) will continue to restrain the economy. Lower interest rates cannot negate the downside risks from trade policy uncertainty, yet that remains where the U.S. finds itself. External phenomena typically do not hold major implications for the U.S. economy, but the problems in the U.S. economy tend to ripple outward. That appears to be the case again.
For commercial real estate (CRE), despite rising uncertainty and increasing policy headwinds, the CRE market is holding up well across major property types. Tariffs have not yet impacted either the industrial or retail sector much. That could change, rather abruptly, if the U.S. pushes ahead with the implementation of tariffs on consumer goods in the fourth quarter. The office sector remains relatively insulted from the trade tensions but would not be completely immune if the situation further deteriorates. The multifamily sector remains driven by domestic demographics. Though slowing, they should not pose a serious threat yet. For the balance of the year, the U.S. CRE market should see little impact from the global economy, but policy decisions at home continue to put the longest expansion in U.S. economic history at unnecessary risk.