The global macroeconomic and political backdrop weakened further over summer. Some of the downside risks we feared in The Big Picture - Renewed Trade Dispute Casts Shadow Over Global Economy , 11 June, have materialised, notably the decision by Donald Trump's administration in late July to escalate the trade war with China, after signalling its intention to hit the remaining USD300bn of imports from China with 10% tariffs. On the announcement in late July, global risk sentiment dived further and global bond yields fell to new lows.
On the back of this, we published A Deep Dive Into The Global Recession Risk , 27 September. We conclude that we see a 30% chance of a global recession over the next one-two years. It is important to note that expansions do not die of old age but of 'disease' and we currently see the biggest risk stemming from exogenous policy shocks, in particular an escalation of the trade war between the US and China. We do not see much evidence of macroeconomic imbalances such as excessive wage growth, overinvestment/consumption, or excessive credit growth, which could trigger a global recession. We still think that major central banks have some ammunition left, although in Europe and Japan in particular it will require substantial political will to adopt new measures. The Fed has more room to manoeuvre. On the fiscal side, the structural decline in global yields means the fiscal space is bigger than it appears at first, allowing room to act if recession risks increase.
We have downgraded our outlook for the global economy in coming years. We now expect global growth of 3.0% in 2019, with a slight pickup to 3.2% in 2020 and 3.3% in 2021 (versus 3.2% in 2019 and 3.4% in 2020 and 2021 in The Big Picture - Renewed Trade Dispute Casts Shadow Over Global Economy , 11 June). Following weakness in coming months, we expect the global economy to stabilise early in 2020 and witness a modest recovery onwards, as the stimulus measures from the global central bank and fiscal easing in China start to kick in.
In response to the weakening outlook for the global economy and sharply falling market-based inflation expectations, major global central banks have eased monetary policy. The outlook for underlying inflation pressures also continues to look muted. As a result, the Fed cut its policy rate in July and September and we expect it to carry out an additional four cuts at the upcoming policy meetings. The ECB cut its policy rate at its September policy meeting and at that time also restarted QE at EUR20bn per month as long as inflation does not meet the target and introduced a tiering system for bank deposits at the central bank. In China, the central bank has cut the reserve requirement for banks and allowed local governments to borrow more.
Market-based inflation expectations, in particular in Europe, have continued to decline further and are now close to record lows. The 5Y5Y inflation swap is currently trading at 1.17%. With the lingering uncertainty, low inflation expectations and accommodative central banks, we do not see bond yields rising from current levels in the next six to 12 months (see Yield Outlook - Long yields set to fall back again , 19 September).
On the UK/Brexit, it is likely we are heading for another Brexit extension followed by a snap election. This may take us closer to the Brexit end game depending on the election outcome; however, this is extremely difficult to predict. The Brexit uncertainty is clearly taking its toll on the economy where business confidence is subdued.
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