William De Vijlder

Ten years after the collapse of Lehman Brothers, assessing to what extent major economies have fully recovered from the ensuing global financial crisis and the Great Recession very much depends on the perspective which is chosen. A mixed picture emerges: in most countries per capita real GDP is higher than before the crisis. But public sector debt hasn’t declined and growth has been slow, despite the expansionary policy stance. Policy rates are still (very) low and central bank balance sheets are vastly bigger. Policy leeway hasn’t been restored which implies that thinking about how to address the next downturn should be high on the agenda.

Since the end of 2017, most countries have witnessed a decline of the Markit PMI index for the manufacturing sector. The pace of decline is slowing however in the past 3 months compared to the previous 3 months. This and the still high level of the index in many countries point towards an ongoing satisfactory growth pace.

Corporate America is increasingly confronted with the consequences of tariff increases and is concerned that more is to come. This is a reminder that protectionism influences the economy not only directly via prices or changes in supply and demand but also indirectly because of increased uncertainty.

Economic prospects have become more uncertain since the beginning of the year. Will the Federal Reserve be more aggressive faced with a US economy operating at full cruising speed? Does the flattening of the yield curve foreshadow a more-severe-than-expected slowdown in 2019? What will be the consequences of higher tariffs? These ambiguities have emerged at the same time as various pressures in the emerging countries.

Growth assumptions for the world economy remain at a high level in 2018 underpinned by a powerful combination of job creation, rising company profits and easy access to financing. Yet sources of concern have multiplied and others have become far more intense, leading to a sentiment of increased uncertainty. This is predominantly related to politics and economic policy, which leaves room for positive surprises, but if nothing changes, it could also result in ever stronger headwinds for consumer spending, business investment and international trade

The flattening of the US treasury curve has received a lot of attention as of late because historically recessions have been preceded by an inversion of the yield curve. A rather flat curve does not imply that a recession is imminent. However, historically once the yield curve starts to steepen after having flattened or inverted, a recession follows quite soon thereafter. Rather than focussing on the slope of the curve, one should wonder when the Fed will stop tightening.

Since the beginning of the year the financial markets and the global economy have reacted to various sources which is inherent, at least in part, in a market economy. We must constantly ask ourselves where the next bit of bad news might spring from, and also keep in mind that better visibility in one area is a reminder to search for other sources of uncertainty elsewhere.

The business climate looks less euphoric, in the US but even more so in Europe. A normalisation or the beginning of a downturn?

Uncertainty has a big impact on the behaviour of households and companies. Unexpected events and their second round effects imply that to some extent it is unavoidable. Economic policy should avoid increasing it further. Whereas monetary policy aims to keep a lid on uncertainty, protectionist measures amplify it and can end up acting as a major headwind to growth.

German business climate indicators have eased since the start of the year, a movement which is broad-based. Very recently, some indicators have stabilised. Corporate uncertainty, as measured by the dispersion of the assessments of the economic outlook, has not increased yet despite concern about a trade war. However, dispersion tends to lag the overall evolution of the business climate so this indicator will need to be monitored closely in the coming months.

Worries about tariff increases are a headwind to growth because of the uncertainty about the outcome and its timing. Global value chains complicate the analysis. Tariffs increase input prices in the importing country and weigh on order books in the exporting country. Since the start of the year, both input prices and export orders have weakened in many countries. It’s probably too early to look for a link with tariff measures and tariff uncertainty.

Recent economic data in the US on the whole have been particularly strong. The labour market numbers released at the beginning of June surprised to the upside with strong job creation. Both the ISM manufacturing and non-manufacturing indices increased further and also beat expectations.

The combination of low real interest rates, job creation, corporate profit growth and growth in international trade should allow the world economy to continue growing at a healthy pace.

The ECB meeting account shows a central bank which is confident about the growth outlook despite the recent softness of data. The concerns relate to global factors which have become more prominent: the threat of trade protectionism. This concern is also echoed by the Federal Reserve.

In recent years, emerging market issuers, in particular corporates, have raised huge amounts of USD debt, thereby increasing their sensitivity to an appreciation of the dollar. Rising US treasury yields, a sudden strengthening of the dollar and country-specific issues have triggered considerable portfolio outflows and a weakening of emerging currencies.

Even if in reality nothing changes, worrying about protectionism may nevertheless act as an economic headwind because threats and counter-threats increase uncertainty.

Markets have reacted in a calm way to the US decision to withdraw from the Iran nuclear deal. Despite the increase in geopolitical uncertainty, there has been no flight to safety and US treasury yields have followed oil higher. Should oil prices continue to increase, this would end up acting as a headwind to growth.

Sentiment indicators have softened globally in recent months, including in the eurozone. The historical experience is varied although cyclical declines in eurozone sentiment have tended to last quite a number of months. Considering the current strong fundamentals, one would expect that weaker sentiment merely points to some moderation of growth.