Warning Signs: Six Charts Signalling A Global Slowdown

Manufacturing index points to global contraction

Activity indices in the manufacturing sector have failed to rebound meaningfully from low levels in the areas which experienced the most weakness last year – Europe, Japan and China. This indicator also drifted lower in the US, confirming the trend of softer growth dynamics in the world’s largest economy.

As a result, the global manufacturing index fell below the threshold which separates expansion from contraction, pointing to a broad-based lack of momentum within the cyclical part of the economy.

Global tensions and uncertainties around trade and tariffs are the key cause of this situation.

By disrupting established global supply chains, unexpectedly raising input costs, and, more importantly, by creating large uncertainties around the future business environment, trade sanctions and tariffs have been a strong headwind for corporate investment and industrial activity.

They are unlikely to abate anytime soon.

Dissipating US stimulus worse than trade wars

The IMF recently revised lower the US growth forecast for 2019 to 2.3%, and to 1.9% for 2020, after projecting a 2.9% increase in 2019 last year.

Various 'real-time' indicators of GDP growth also point to softer expansion for the second quarter, between 1% and 1.5% annualised growth.

Although external factors such as tariffs and trade uncertainties have had a negative impact, they are not the only factors to blame.

Domestic fiscal policy is having an adverse impact on growth, or more precisely, a less positive impact compared with last year.

The impetus provided by President Donald Trump's Tax Cuts and Jobs Act boosted GDP growth last year by about 0.7%, but the impact of these tax cuts is dissipating over time.

It is estimated to represent 0.4% this year, and, if no new legislation is enacted, it may become a negative contributor to GDP growth in 2020.

Independently of tariffs and trade tensions, the US economy was bound to slow this year, and it can hardly accelerate without another round of fiscal stimulus and a widening public deficit.

Industrial 'air pocket' could impact US economy

A combination of external factors and internal developments has exerted significant pressure on the US industrial sector this year.

New export orders have stopped growing – affected by slowing global growth, investment, consumption and trade.

The fallout of the 2018 tax cut-driven investment spree and softer demand also resulted in slowing capex. Finally, job creation in the manufacturing sector has basically ceased.

For the moment, this soft patch appears to be contained within the industrial sector.

However, the longer this industrial 'air pocket' lasts, the more it risks impacting the entire US economy, particularly if it affects business and household confidence.

In the meantime, entertaining the prospect of monetary easing is a way for the Federal Reserve to support confidence.

Yen and franc regain safe-haven status

The bullish trend for risky assets, which started at the beginning of 2019, reversed as the trade war jumped back into the spotlight.

On the other hand, dovish central banks have contributed to the rally in risk-off assets in government bonds, gold and currencies such as the Swiss Franc and the Japanese yen.

In the current low volatility environment for FX markets, both currencies have regained safe-haven status and were up 1.8% and 2.9% against the dollar. This comes after the franc lost its safe-haven status in April, due to the Swiss National Bank's easing bias.

With markets now pricing interest rate cuts in the US and questions surfacing about weakening global growth and increasing probabilities for a recession, safe-haven currencies could continue to shine.

Political uncertainty translates to market volatility

President Trump's tweet at beginning of May regarding an increase in trade tariffs with China magnified concerns about continuing sluggish growth.

This highlights the trade war is acting as a drag on sentiment, which may then filter down to the economy through lower investment, production and consumption – especially given current lacklustre dynamics.

So far, the dispute has essentially been limited to the US and China, but retaliation seems likely to be extended in the coming months to other goods, services or geographical areas such as Europe and Japan.

As a result, equity markets fell in May – the MSCI World l.c. was down 6% – and the VIX jumped from 13 to 19 on the back of this toxic mix of growth disappointment and trade war uncertainties.

The situation is reminiscent of 2003, when geopolitical uncertainties before the Iraq invasion drove equity markets and rates down.

European rates mirror Japan as economies converge

For the past two decades, the European economy has structurally converged towards a Japan-like scenario. European demographic trends, low growth, dampened price pressures, high public debt, unorthodox monetary policies all exhibit striking similarities to Japan.

However, since last year, euro rates have been converging back toward Japanese counterparts, along with GDP growth, inflation and monetary policy.

Back in negative territory, German 10-year government yields fell below 10-year JGBs in May – at -0.20% compared to -0.09% – for only the third time ever. Both the European Central Bank (ECB) and the Bank of Japan (BoJ) brought key short-term rates into negative territory in 2016.

However, in 2017, the eurozone experienced a bout of growth acceleration. This led to an upward repricing of rate expectations, with the ECB openly speaking about monetary normalisation, and long-term government rates rising back toward 2015 levels.

On the contrary, in Japan, BoJ interventions and the small margin for a revival of inflation and nominal growth kept government long-term rates anchored close to zero.