Fed Takes Itself Out of the Picture
Nine months ago, the global economy faced two key risks. First, there was genuine concern that the Federal Reserve (Fed) might tighten too aggressively. At the time, the Fed was engaged in steady policy normalization with quarterly rate hikes and balance-sheet reduction, and providing guidance towards three further rate hikes for 2019. Second, the imposition of 10% tariffs on $200 billion of Chinese goods had ignited concerns that the trade dispute would escalate “on schedule” and the US would follow through with its threat to increase tariffs to 25% on January 1, 2019.
Given such clouds on the horizon, the subsequent market meltdown in late 2018 was understandable. But there was a silver lining: the episode served to sensitize policymakers to the fragility of the global economy. The Fed, for its part, made a dramatic U-turn, initially trimming one rate hike from the expected path in 2019. By March 2019, it had done away with the remaining two, essentially taking itself out of the picture with respect to possible hikes. In doing so, the Fed shifted from being a threat to the extension of the cycle to becoming an enabler of it. In our view, having already hiked nine times in this cycle, the Fed can afford to be “patient” and even has scope to be “nimble.” Indeed, as trade tensions recently re-escalated, Fed Chair Jerome Powell emphasized that the Federal Open Market Committee stands ready to “act as appropriate” to sustain the expansion. Despite having made little progress on the road towards policy normalization, other central banks have followed suit on this dovish tilt.
Trade Tensions Risks Re-emerge
Having initially improved after the December G20 meeting in Argentina, actions and rhetoric around trade have worsened considerably since early May. This remains a major risk for the global economy – the most important one, in fact. Indeed, a ratcheting up of current tensions into a full-blown trade war could swiftly derail the global economy’s progress towards stabilization made so far this year. But if the June G20 meeting in Japan brings another respite, allowing talks to continue and further tariff escalation to be avoided (give or take periodic outbursts of protectionism), there are reasons to believe that the current economic cycle – already the longest on record in the US – could continue.
Cycle Could Extend, But Growth will be Modest
Despite its longevity, US expansion during this cycle has been quite weak (see Figure 2). Such labored recoveries are typical following deep financial crises such as that in 2008, and the subdued performance was further dampened this time around by forces such as aging populations. Moreover, there is little evidence of the types of excesses that have historically caused unsustainable imbalances in the economy, sometimes triggering a sudden end to the cycle. For instance, the US personal savings rate is relatively strong and the household debt service ratio is quite low. In most developed economies, including Europe, private consumption should be underpinned by firm labor market conditions and rising labor incomes. This is an important stabilizing factor that can help the global economy weather the current soft patch. While select pockets of overleverage or valuation concerns exist, particularly on the corporate side, they do not appear as yet to be systemically destabilizing. More dovish central banks can be quite helpful here.