14 January 2020
The latest FLI reading suggests growth rates are tipped to plateau at levels considerably below the peaks seen in 2013 and 2017, and two-way risks could re-emerge. Overall this suggests investors should take a neutral stance on risk and duration. This is driven by mixed signals from the underlying sectors.
In good news, business surveys extended their position in the top-right quadrant of the chart (signifying growth above-trend and accelerating). Globally, manufacturing surveys have shown signs of bottoming out, as suggested by healthier ratios of new orders to inventories. Service-sector surveys are also better off after a rough patch of ‘catching down’ to their industrial survey counterparts. China has been a notable contributor to PMI pick-ups. Meanwhile, global trade remains in the top-right, and had a better end to 2019.
In less positive news, the consumer/labour indicator continues to be stuck in the top-left quadrant (indicating growth that’s below-trend but improving). The sector is being particularly held back by global consumer confidence, which has peaked in many major developed markets (DMs). The US labour market also shows signs of weakening, with the recent rise in initial unemployment claims; the US slowdown, especially in the industrial sector, could be spilling over to the consumer sector.
Commodity-linked leading indicators are less encouraging after a strong run and have moved into the bottom-left quadrant (signalling growth that’s below-trend and deteriorating). The key driver has been the sharp fall in the Baltic Dry index. This may not be of immediate concern, with spot prices of industrial metals finally showing signs of life.
Industrial orders continue to be the laggard, deteriorating further. Japan’s economy has been particularly underperforming after its typhoon and VAT hike. US durable goods continue to be weak but have shown some signs of stabilisation. Europe is more positive, with a continued rebound in Germany’s foreign orders after a horrible spell in early 2019.
Easier monetary conditions soften downside risks, but concerns remain
The largest positive driver of economic activity is undoubtedly global monetary conditions, which eased significantly throughout 2019. The peak-to-trough decline in sovereign yields was, in many DMs, comparable to 2007-09. The Fed is aggressively expanding its balance sheet again, and almost every major emerging market central bank has lowered policy rates. This will boost growth, with the lagged impact now increasingly being felt. Meanwhile, Chinese stimulus from the first half of 2019 should keep underpinning many economic sectors; a key global variable is whether we again get stimulus “front-loaded” in the first half of this year.
To an extent, global downside risks have eased. Indeed, we could even see the effect of a US-China ‘Phase 1’ trade deal and a ‘Boris/Brexit Bounce’ show up in data as sentiment improves.
However, concerns remain; we will almost never be able to say that US-China policy uncertainty has gone away, given structural misalignments between the two global powers, and Brexit looks set to be of the ‘hard’ variety. Moreover, recent geopolitical developments in the Middle East have pushed oil prices higher, which could be a modest drag on growth.
Elsewhere, the hangover from US fiscal stimulus against a mature credit cycle, tight labour markets, and growing uncertainty around the US election will weigh on the US. The lack of spare capacity in many countries’ labour markets partly explains the lower ‘speed limit’ on this cyclical recovery.
In all, despite a broadly optimistic picture for the coming few months, the FLI recommends a neutral stance on risky assets and duration. The growth picture looks murky after this, with acceleration approaching zero, but it is worth watching for a boost in data from recent positive developments in US-China relations and UK politics.
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