Leading indicators of economic activity in many countries, including the US and Australia, have taken a softer turn during June increasing the risk of softer prospective global economic growth. International trade readings for many of the world’s most export-driven economies have deteriorated sharply in response to the US/ China trade war. Labour market indicators, however, continue to hold up well, especially in the US where consumer spending is strong as well. The worlds central banks are responding to what are downside risks to global growth at this stage by either easing monetary policy or turning towards considering easier policy. With interest rates already unusually low limiting monetary policy fire power central bankers are also starting to ask Governments to do more of the heavy lifting work to promote stronger economic growth.
In the US, economic growth remains quite strong. The final reading of Q1 GDP growth is due later this week and is likely to show annualised growth at or even a little better than the previously reported 3.1%. By the end of July, the advance reading of Q2 GDP will be released and at this stage seems to be tracking close to 3% assisted by strong growth in consumer spending in the quarter. The main reason why consumer spending has probably strengthened in Q2 is that US consumers have been in a great position to spend. The unemployment rate at 3.6% in both April and May is the lowest in 50 years. Wages growth at 3.1% y-o-y is close to the strongest in 10 years. Household wealth has lifted sharply in the first half of 2019 primed by strongly rising US asset prices.
US households and companies have enjoyed strong income growth helping the economy to grow well. The problem is that downside risks are starting to mount. Many US companies are starting to warn of downward pressure on profit margins and ultimately profits as the trade war between the US and China negatively affects US exports and the import supply chain for US producers. Unsurprisingly, the escalation of the trade dispute in May and June is starting to reflect in much gloomier purchasing manager (PMI) survey results from US manufacturers. The earliest of the regional June manufacturing reports from New York State (down to -8.6 in June from +17.8 in May) and Philadelphia (down to +0.3 in June from +16.6 in May) indicate that manufacturing may move rapidly from healthy expansion to stalling speed or worse.
The changing fortunes of the US manufacturing sector largely because of the US/ China trade war could cut away a key part of President Trump’s electoral support base in key states that helped him win the presidency in 2016. Potential US manufacturing sector weakness is likely to place pressure on President Trump to start trying to deescalate the trade war with China in our view.
The US Federal Reserve (Fed) is also watching trade war developments keenly. If the trade war persists too long or escalates it will compromise US economic growth prospects causing the Fed to start cutting the funds rate. Essentially the Fed has spent the first half of 2019 moving away from an earlier objective to lift interest rates to a neutral setting, to declaring interest rates are about right, to preparing in the May and the most recent June policy meetings for a possible rate cut. All hinges on trade war developments and what damage to US economic growth prospects is likely to occur. While low yields in the US bond market clearly show that the market expects the Fed to cut the funds rate, the Fed is indicating that it will wait for more developments, especially trade war developments, before deciding whether a rate cut is necessary.
In China, the authorities are in little doubt that the trade war is hurting growth prospects with President Xi warning in a recent speech that China faces challenging times, a modern – day equivalent of the long march. May data reports point to slippage in the pace of economic growth in Q2 (Q2 GDP report due mid-July). May exports rose but only 1.1% y-o-y after falling 2.7% y-o-y in April. May fixed asset investment spending decelerated unexpectedly to 5.6% y-o-y from 6.1% in April and industrial production growth was weaker than expected as well at 5.0% y-o-y from 5.4% in April. The only bright spot in the May data was a stronger than expected lift in retail sales to 8.6% y-o-y from 7.2% in April. The authorities are cautiously deploying more expansionary fiscal and monetary policy, but not yet near the scale necessary to give domestic spending growth a chance to offset international trade weakness. At this stage, it is likely that China’s GDP growth rate will slip to 6% y-o-y or lower in Q2 and Q3.
In Europe most leading economic indicators have stayed weak in June. The June manufacturing PMI stayed below the 50 expansion/contraction line only edging up to 47.8 from 47.7 in May. June consumer confidence fell to -7.2 from -6.5 in May. While most monthly economic readings are still consistent with annual GDP growth holding around 1.2% y-o-y in Q2, the same as in Q1, the European Central Bank is becoming increasingly concerned about downside risks to European economic growth prospects and is thinking aloud about what other unconventional monetary weapons it may be able to deploy in need. The approaching leadership change in Britain is also causing some concern as the most likely next British Prime Minister, Boris Johnson, continues to declare that Britain will exit the EU at the end of October either with a deal that he does not appear to want to actively try and renegotiate or without a deal where he seems uncomprehending of and so oblivious to the consequences.
In Australia, the latest Q1 GDP report showed slightly better quarterly growth at 0.4% q-o-q (0.2% in Q4 2018) although annual GDP growth slipped to 1.8% y-o-y in Q1 from 2.3% in Q4. Since mid-2018 quarterly GDP growth has been weighed down by falling spending on housing and very soft growth in household consumption spending. Other parts of the economy have been growing reasonably well including government spending, some parts of business investment spending and net exports. Looking ahead, although there are tentative signs that the downturn in home buying activity and house prices may be coming to and end, falling home building activity is likely to persist well into next year with new home building approvals still falling over 20% y-o-y.
Consumer spending growth is also still beset by high household debt levels and slow growth in household income. Lower interest rates after the RBA cut the cash rate 25bps to 1.25% at its early-June policy meeting and tax cuts coming when personal income taxpayers put in their returns for 2018-19 should help to boost consumer spending and GDP growth in Q3 and Q4 although probably not enough to boost GDP growth much above 2.5% y-o-y, insufficient to drive down further the national unemployment rate sitting at 5.2% in May and June despite relatively strong employment growth.
The June RBA rate cut, the first in three years, marked the culmination of an evolution in RBA monetary policy thinking through May and June towards more actively using lower interest rates to try and drive the unemployment rate down towards 4.5%. With annual inflation languishing below the RBA’s 2-3% target band and GDP growth unlikely to pick up enough pace to fully utilize employment resources the RBA believes lower interest rates can be deployed to encourage better growth performance and without igniting untoward upward pressure on inflation. The RBA has indicated that another rate cut is likely but it also recognises that monetary policy change alone cannot deliver sustainable stronger longer-term economic growth prospects. It needs Government to assist with more infrastructure spending and economic reforms capable of lifting productive capacity.