Monaem Sarker :
The past few weeks have been a tumultuous ride for the global economy, as the US-China trade war unexpectedly escalated and the new UK Prime Minister’s hardline approach to leaving the European Union has boosted fears that a no-deal Brexit may very well occur on October 31. There was further evidence of a global slowdown, notably in Germany and China. Geopolitical events have also been in the news, including the rising tensions in Hong Kong and the dissolution of the Italian government. Financial markets have reacted strongly to this complex, turbulent picture. Equity markets have been volatile. Long-term bond rates around the world have moved down sharply to near post-crisis lows.
Meanwhile, the US economy has continued to perform well overall, driven by strong consumer sentiment and spending. Job creation has slowed from last year’s pace but is still above labour force growth. Inflation seems to be moving up closer to 2%. However, clouds are gathering across other parts of the global economy, including from a pronounced escalation in trade policy uncertainty.
With short-term interest rates already low, the US Federal Reserve has little room to cut borrowing costs to spur spending and investment as it usually does in a slowdown. Meantime, the federal debt is exploding, which could hamstring any efforts to boost growth with tax cuts or spending increases. Another interest rate reduction by the Federal Reserve might be needed to guard against the risk that a slowdown in US business investment and global manufacturing activity doesn’t spill over into other parts of the domestic economy. We don’t think the US economy is headed towards a recession right now. A glance at the incoming data shows solid domestic momentum that point to a continued, though slowing, economic expansion. The labour market is strong, consumer confidence is high, and consumer spending is healthy. However, the trade war has aggravated a global economic slowdown that has weakened US manufacturing and business investment, clouding an otherwise solid domestic outlook. It is worth noting if weakness in global manufacturing activity seeps into the services sector and leads to a slowdown in hiring. A couple of poor monthly payroll figures could in turn damage consumer confidence.
Tariffs: President Trump announced another round of tariffs on $300 billion of Chinese imports that had thus far largely avoided becoming tangled up in the trade dispute. President Trump stiffened tariffs on Chinese imports after Beijing unveiled its own new levies on American goods, the latest twists in a trade war rattling investors and confounding central bankers.
The President’s stance represented a new phase in his longstanding drive to shape US corporate planning to align with his desire to see US companies invest domestically and to force changes in China’s behavior that he says harms US companies and consumers. The uncertainty created by that strategy has posed continuous challenges to the Fed’s monetary policy, with Federal Reserve Chairman Jerome Powell saying that the Fed stood ready to stimulate the economy as needed but that trade uncertainties compounded the risks to the global economic outlook.
US Dollar: A prolonged dollar rally is pressuring US corporate earnings, hitting commodity prices and threatening to deepen a selloff in emerging markets. The US dollar has continued to grind higher this year despite an escalating trade fight with China and broadsides from President Trump, who has complained that the dollar’s strength is curbing growth. In July, the dollar rose even after the Federal Reserve cut interest rates for the first time in a decade, defying expectations that lower rates would cut the appeal of US assets to yield-seeking investors.
One key driver of the dollar’s gains has been the relative strength of the US economy, which since 2015 until recently has allowed the Fed to raise rates far above the levels of borrowing costs in other developed countries. The gap in yields is likely to remain in place as central banks ease monetary policy to counter the effects of a global slowdown. The strong dollar is a negative for US exporters and is also hurting US multinationals by making it more expensive for them to convert foreign revenues into US currency – a worrisome trend for investors betting on an earnings rebound in the second half of 2019. At the same time, the dollar’s strength has made investors more cautious on emerging markets, as a rising dollar makes it more expensive for these countries to service their dollar-denominated debt, pressuring those that have borrowed heavily in the US currency.
Commodities, e.g., oil, copper and most other raw materials, have not only been buffeted by growth fears and the trade-war escalation, they have also been hurt by the strengthening dollar. These commodities are denominated in dollars and become more expensive to foreign buyers when the US currency appreciates.
China: China’s producer prices fell into deflation for the first time in three years, as worries over the trade war with the US sapped demand, adding another complication to Beijing’s efforts to shore up its slowing economy. Factory-gate prices act as a bellwether of industrial demand in China. As trade tensions with the US escalate, global demand for Chinese goods will erode, further weighing on prices of industrial goods. While producer prices fell 0.3% from a year earlier in July, consumer prices edged up to a 17-month high, squeezing households’ spending power. This presents a potential dilemma for China’s central bank. It could loosen monetary policy in a bid to stimulate demand and lift producer prices out of deflation, but a massive stimulus program would risk pushing consumer inflation higher and cause the property market to overheat.
Eurozone: The eurozone economy slowed sharply in the second quarter, with growth at an annualized 0.8% rate in the three months through June, a slowdown from 1.8% in the first three months of 2019. The drop in growth has been led by manufacturing, particularly factories in Germany and Italy, the two eurozone economies most dependent on the sector. Continued trade uncertainty delivered a blow to manufacturing confidence, which fell to its lowest level for six years in July. However, trade uncertainty isn’t the only drag on European manufacturing. Auto makers wrestling with new rules on carbon emissions and an anticipated shift away from gasoline have seen sales fall. Consumer sentiment levels in Europe are also low, consistent with levels that have historically preceded a recession.
The UK’s departure from the EU is also a source of volatility. There is now a heightened likelihood that the UK will leave the EU without an agreement to smooth its exit, which would hit eurozone manufacturers. The eurozone’s weakness makes it more likely that the European Central Bank will roll out new stimulus measures in September in an effort to limit the impact of the manufacturing sector on the rest of the economy, which is in better shape.
Outlook: Two developments in the last few weeks have had a pronounced impact on the global financial markets: The US Federal Reserve cut interest rates for the first time in over a decade and the US-China trade war has expanded to include tariffs on an additional $300 billion of goods coming into the US from China.
The trade war is harming business confidence, leading to a visible pullback in investment that could eventually imperil job growth, which has been healthy. This rising uncertainty over trade policy adds to a growing list of geopolitical tensions, including protests in Hong Kong, Britain’s threat to crash out of the European Union on Oct. 31, a political crisis in Italy that could roil the euro, conflicts between Japan and South Korea, and India’s military lockdown in the Kashmir region bordering Pakistan.
Despite the hand-wringing these events have caused in global financial markets, the direct effects on economic growth are not terribly consequential. That said, turmoil in financial markets, should it continue, could sap consumer and business confidence. These “second order” effects on the global economy could cause us to be less sanguine.
Political leaders are inflicting avoidable pain on the economy with little to show for it. Central banks’ tools aren’t well-suited to deal with the political sources of economic weakness. Moreover, with borrowing costs already low, the Central Banks in developed countries have less room to cut interest rates to spur growth.
(Monaem Sarker, politician, columnist and presently Director General, Bangladesh Foundation for Development Research)
