The extent of the US soft patch will be important for risk assets and bond yields. We look for an only a moderate slowdown, but expect ISM to come down in the coming quarters. Volatility is expected to remain high for some time.
Still no signs of a turnaround in the euro area, while Japan is recovering and China shows resilience.
The performance of the US economy over the coming quarters will be very important for risk assets as well as government bond yields. As we wrote in last week’s Strategy: The straw that broke the camel’s back, the weak US retail sales for September, seemed to trigger the strong sell-off in risk assets at the end of last week. Since then, stocks have bottomed from technically oversold levels. Whether this is just a technical correction higher or a real turnaround depends on a number of issues, not least on how much the global economy is slowing down. This in effect will very much depend on how the US evolves over the coming quarters.
If we see only a moderate slowdown of US growth, the decline in risk appetite should prove fairly short-lived as well. However, if US growth slows more sharply without Europe having recovered, we could be in for a longer period of weakness in risk assets.
When forecasting the economic development, we generally distinguish between short-term and medium-term impulses. The short-term impulses drive the cyclical swings around the broader medium-term cycle. The US economy currently faces some short-term negative impulses - or headwinds - from a number of places:
1. Growth in export markets has weakened. The euro area has clearly slowed down this year and we still see limited signs of a turnaround (more on this below). Japan took a sharp hit from the VAT hike and although there are tentative signs of bottoming, the picture is still overall weak. China has slowed over the summer too, although PMI data suggest it is only a moderate slowdown so far.
2. Stronger USD. The USD has strengthened 8% on a trade-weighted basis over the past six months. A standard multiplier suggests a 10% stronger USD reduces GDP by 0.4 percentage points after a year. If this relationship holds, the USD strengthening so far is likely to reduce growth by about 0.25 percentage points over the next two to three quarters.
3. ‘Normalisation’ of consumer spending. US growth got a temporary boost from the post-winter rebound in retail sales, as the negative shock from the extremely cold weather disappeared. However, retail sales for September suggested that consumer spending is normalising back to the underlying trend of around 4% growth in nominal sales, coming from 6-7% in spring and early summer.
4. Financial market uncertainty. The recent turmoil in financial markets will have a small negative impact on sentiment and may slow investment growth a bit after the strong momentum of capex during 2014.
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