Global economic outlook remains firm
Global economic growth should register roughly 3 percent for the year, in line with our expectations. That would keep the growth rate for 2018 level with 2017. Despite some weakening during the latter half of 2018, the overall picture for the economy remains robust. Headlines have recently focused on slowing, but we view this as more of a temporary blip, not the beginning of a meaningful downshift. We do not foresee significant slowing in the global economy and therefore calculate only a minor risk of a global recession in the near term.
Despite growth holding steady in 2018, the composition of growth changed significantly relative to 2017. For major economies, 2017 was marked by synchronization of growth. Among the 10 largest national economies, only India’s economy slowed in 2017. But in 2018, the trend largely reversed. Among the top 10 economies in the world, only the U.S. and India likely accelerated while the other 8 decelerated. Sadly, the world’s two largest economies find themselves in the midst of an internecine trade war.
For the U.S., the largest economy in the world, growth versus 2017 leapt by roughly 70 basis points, fueled by fiscal stimulus, largely in the form of the tax cut passed in late 2017. Growth surged during the middle of the year which should bring U.S. growth to around 3 percent. That would represent the high watermark during the current expansion. The impact of fiscal stimulus is already fading and growth remains above potential heading into 2019. But headwinds are emerging, particularly on the policy front. The Federal Reserve raised rates 100 basis points during 2018 and looks set to continue tightening in 2019, albeit at a slower pace. And trade policy, particularly regarding China, continues to negatively impact growth in a small but measurable way.
In China, the world’s second-largest economy, growth also looks set to slow in 2018. Economic growth should still register in the mid-6-percent range, quite robust for an economy of its size. In recent months, growth has slowed due to declining exports, weaker investment growth, and growing inventories. Loss of momentum and fallout from the trade war with the U.S. have spurred policymakers into action. The People’s Bank of China (PBOC) has generally loosened policy in 2018, the only major central bank to do so. The short-term yuan rate has fallen 150 basis points since last spring and the PBOC continues to reduce reserve ratios. It will take some time for these stimulative measures to have an impact, but we believe that they will toward the latter half of 2019.
In other major Asian economies, growth has been mixed. Growth in Japan for 2018 should come in below 2017’s growth rate. Much of this stems from a rather sharp contraction in the third quarter, but that came as a result of one-time idiosyncratic factors such as poor weather and natural disasters. Growth should rebound slightly in 2019. In India, growth should accelerate in 2018, rebounding after a slowdown in 2017 due to the demonetization of the currency. Although growth has slowed in recent quarters, due to net exports and declining private sector output, India should rank as the fastest-growing large economy for the year.
In Europe, major Eurozone economies, notably Germany and Italy, contracted during the third quarter. In Germany, industrial production has been slowing. Although the auto sector gets credit for the majority of the blame, the slowdown looks more widespread. A recession looks unlikely in 2019, but growth could remain flat. In Italy, growth showed a slight contraction in the third quarter, due to a decline in domestic demand. Recent survey data does not portend a rebound and Italy may have already entered a recession. In France, growth also slowed in 2018. Although the government has recently backed away from some tax hikes, domestic demand is declining, and risks are increasing. Unsurprisingly, growth in the Eurozone is also expected to slow in 2018, falling toward 2 percent. In the UK, although Brexit has garnered most of the headlines, other economic issues exist. The current account deficit is widening, the pound is depreciating (though some of both of those could be ascribed to Brexit concerns), and economic growth is slowing. We do not expect a recession in 2019 (growth looks to recover slightly), but given the uncertainty surrounding Brexit, risk clearly lies on the downside. Slowing growth in major global economies raises the question: how is global growth holding up? The U.S. economy represents roughly 25 percent of the global economy so significant acceleration packs quite a punch. Growth outside of major economies, despite some challenges in emerging economies due to the appreciating U.S. dollar, has held up well. That has helped to offset the deceleration in growth from major global economies.
Monetary conditions converge, but in reverse
Monetary conditions around the world have converged in recent months, but in reverse. During most of 2018, as the Fed tightened, interest rates generally increased. Although only the Fed was consistently raising policy rates, government bond rates around the world generally increased, as U.S. Treasury yields increased, and growth appeared to accelerate. But faltering growth prospects and the perception of increased risks caused yields around the world to retrench during the last few months. The Fed revised down their forecast for rate hikes in 2019 and no other major central bank looks set to tighten at all in the year head with economic growth slowing. The notable outlier among major central banks is the PBOC which should continue loosening to help stave off slowing growth. Central bank balance sheets, notably the Fed’s and the European Central Bank’s, should wind down or at least halt the increase. In 2019 yields around the world look set to take their cues from the Fed, which will intently focus on the data, notably inflation. If inflation remains relatively benign, yields should rise only modestly. But if inflation surprises on the upside, yields could head higher again.
Implications for the U.S.
Although economic growth should slow in 2019, it should still support the U.S. economy. Recent caution on the part of the Fed could put downward pressure on the dollar, supporting exports. But the big wild card remains trade policy, which thus far has mildly restricted economic growth. The U.S. and China will aim to bridge their differences in the first quarter, but the short time frame makes reaching an agreement challenging.
The volatility in the markets and the tightening of financial conditions has altered the outlook for monetary policy. With economic growth in the U.S. set to slow to around 2.5 percent this year, we look for the Fed to hike only 1 or 2 times unless inflation significantly surprises to the upside. The yield curve has continued to invert, even if briefly, as faith in the longer-term outlook has diminished – the opposite side of the coin.
None of this portends gloom for commercial real estate (CRE). The fundamental space markets continue to hold up well, even amidst slight deterioration. This is largely owed to rising supply, not a significant pullback in demand. The CRE market looks more like equilibrium and less like deterioration.
CRE capital markets are not feeling the pain like their publicly-traded compatriots. Quite the contrary, sophisticated investors view CRE more favorably during periods of increased volatility. And CRE volumes surprised on the upside in 2018. With supply growth modest by historical standards and the use of leverage still reasonable, CRE capital markets could outperform again in 2019.