Economic Outlook: US-China trade tension weakens demands

A combination of many factors has orchestrated a sluggish global growth in July global economic outlook. However,  financial market sentiment; continued fading of Euro drags; stabilization in Turkey and Argentina emerging markets and avoiding Iran-Venezuela collapses would  be the needed elixir

By Daniel Akintunde

The global economic growth has remained subdued.

Since the April World Economic Outlook (WEO) report, the United States further increased tariffs on certain Chinese imports and China retaliated by raising tariffs on a subset of US imports. Additional escalation was averted following the June G20 summit. Global technology supply chains were threatened by the prospect of US sanctions, Brexit-related uncertainty continued, and rising geopolitical tensions roiled energy prices.

Against this backdrop, global growth is forecast at 3.2 percent in 2019, picking up to 3.5 percent in 2020 (0.1 percentage point lower than in the April WEO projections for both years). GDP releases so far this year, together with generally softening inflation, point to weaker-than-anticipated global activity. Investment and demand for consumer durables have been subdued across advanced and emerging market economies as firms and households continue to hold back on long-range spending. Accordingly, global trade, which is intensive in machinery and consumer durables, remains sluggish. The projected growth pickup in 2020 is precarious, presuming stabilization in currently stressed emerging market and developing economies and progress toward resolving trade policy differences.

Risks to the forecast are mainly to the downside. They include further trade and technology tensions that dent sentiment and slow investment; a protracted increase in risk aversion that exposes the financial vulnerabilities continuing to accumulate after years of low interest rates; and mounting disinflationary pressures that increase debt service difficulties, constrain monetary policy space to counter downturns, and make adverse shocks more persistent than normal.

Multilateral and national policy actions are vital to place global growth on a stronger footing. The pressing needs include reducing trade and technology tensions and expeditiously resolving uncertainty around trade agreements (including between the United Kingdom and the European Union and the free trade area encompassing Canada, Mexico, and the United States). Specifically, countries should not use tariffs to target bilateral trade balances or as a substitute for dialogue to pressure others for reforms. With subdued final demand and muted inflation, accommodative monetary policy is appropriate in advanced economies, and in emerging market and developing economies where expectations are anchored. Fiscal policy should balance multiple objectives: smoothing demand as needed, protecting the vulnerable, bolstering growth potential with spending that supports structural reforms, and ensuring sustainable public finances over the medium term. If growth weakens relative to the baseline, macroeconomic policies will need to turn more accommodative, depending on country circumstances. Priorities across all economies are to enhance inclusion, strengthen resilience, and address constraints on potential output growth.

Weak final demand

Against a difficult backdrop that included intensified US-China trade and technology tensions as well as prolonged uncertainty on Brexit, momentum in global activity remained soft in the first half of 2019. There were positive surprises to growth in advanced economies, but weaker-than-expected activity in emerging market and developing economies.

Growth was better than expected in the United States and Japan, and one-off factors that had hurt growth in the euro area in 2018 (notably, adjustments to new auto emissions standards) appeared to fade as anticipated.

Among emerging market and developing economies, first quarter GDP in China was stronger than forecast, but indicators for the second quarter suggest a weakening of activity. Elsewhere in emerging Asia, as well as in Latin America, activity has disappointed.

Despite the upside surprises in headline GDP for some countries, data more broadly paint a picture of subdued global final demand, notably in fixed investment. Inventory accumulation of unsold goods lifted first quarter GDP in the United States and the United Kingdom, while soft imports boosted output in China and Japan.

From a sectoral perspective, service sector activity has held up, but the slowdown in global manufacturing activity, which began in early 2018, has continued, reflecting weak business spending (machinery and equipment) and consumer purchases of durable goods, such as cars. These developments suggest that firms and households continue to hold back on long-range spending amid elevated policy uncertainty.

Soft global trade

Spending patterns are also reflected in global trade, which tends to be intensive in investment goods and consumer durables. Trade volume growth declined to around ½ percent year-on-year in the first quarter of 2019 after dropping below 2 percent in the fourth quarter of 2018. The slowdown was particularly notable in emerging Asia.

Weak trade prospects—to an extent reflecting trade tensions—in turn create headwinds for investment. Business sentiment and surveys of purchasing managers for example point to a weak outlook for manufacturing and trade, with particularly pessimistic views on new orders. The silver lining remains the performance of the service sector, where sentiment has been relatively resilient, supporting employment growth (which, in turn, has helped shore up consumer confidence). 

Muted inflation

Consistent with subdued growth in final demand, core inflation across advanced economies has softened below target (for example in the United States) or remained well below it (euro area, Japan). Core inflation has also dropped further below historical averages in many emerging market and developing economies, barring a few cases such as Argentina, Turkey, and Venezuela.

With global activity generally remaining subdued, supply influences continued to dominate commodity price movements, notably in the case of oil prices (affected by civil strife in Venezuela and Libya and US sanctions on Iran). Despite the large run-up in oil prices through April (and higher import tariffs in some countries), cost pressures have been muted, reflecting still-tepid wage growth in many economies even as labor markets continued to tighten. Headline inflation has therefore remained subdued across most advanced and emerging market economies. These developments have contributed, in part, to market pricing of expected inflation dropping sharply in the United States and the euro area.

Mixed policy cues and shifts in risk appetite

Policy actions and missteps have played an important role in shaping these outcomes, not least through their impact on market sentiment and business confidence. While the six-month extension to Brexit announced in early April provided some initial reprieve, escalating trade tensions in May, fears of disruptions to technology supply chains, and geopolitical tensions (for example, US sanctions on Iran) undermined market confidence.

Risk sentiment appears to have regained some ground in June, supported by central bank communications signaling the likelihood of further accommodation. Following the June G20 summit, where the United States and China agreed to resume trade talks and avoided further increases in tariffs, market sentiment has been lifted by the prospect of the two sides continuing to make progress toward resolving their differences. Financial conditions in the United States and the euro area are now easier than at the time of the April WEO, while remaining broadly unchanged for other regions.

The projected pickup in global growth in 2020 relies importantly on several factors: (1) financial market sentiment staying generally supportive; (2) continued fading of temporary drags, notably in the euro area; (3) stabilization in some stressed emerging market economies, such as Argentina and Turkey; and (4) avoiding even sharper collapses in others, such as Iran and Venezuela. About 70 percent of the increase in the global growth forecast for 2020 relative to 2019 is accounted for by projected stabilization or recovery in stressed economies. In turn, these factors rely on a conducive global policy backdrop that ensures the dovish tilt of central banks and the buildup of policy stimulus in China are not blunted by escalating trade tensions or a disorderly Brexit.