Picture: 123RF/Aleksandr Belugin
Picture: 123RF/Aleksandr Belugin

Signs that the slowdown in global economic activity is deepening, and that major global central banks lack the firepower to fight back, come at the worst possible time for SA’s fragile economy, as it strains to mount a recovery.

Tension in the Middle East over oil, the cautious stance of the US Federal Reserve on the future path of interest rates, and crumbling data out of Europe have all knocked risk sentiment, as has ongoing uncertainty over US-China trade talks and a possible no-deal Brexit.

As global trade volumes continue to fall, every major economy is now experiencing "a full-blown" industrial slowdown, notes Barclays Research.

Things are looking especially dire in Europe. At 45.7 in September, the IHS Markit eurozone manufacturing purchasing managers’ index (PMI), a measure of industrial health, is now at a seven-year low.

Germany has been most affected by the collapse in world trade due to its reliance on exports for growth, notes S&P Global Ratings. Italy is next in line. Both countries are on the brink of recession.

Germany’s manufacturing PMI fell to 41.7 in September from 43.5 in August, the lowest reading since June 2009. (In SA, the manufacturing recession is also deepening. SA’s September manufacturing PMI dropped to 41.5, which is also its lowest level since the 2008/2009 recession.)

"The eurozone economy is slowly starting to feel the effects of the trade-related manufacturing slowdown," says S&P senior economist Marion Amiot. And with global trade growth hovering around zero, S&P expects this economic weakness to extend into 2020.

The International Monetary Fund is expected to downgrade its 2019 global growth forecast of 3.2% next week. It considers the likelihood of a rebound in 2020 "precarious" and warns that too much reliance is being placed on global central banks, which have been cutting interest rates to the bone.

In addition to the US Fed, 12 other central banks cut rates in September (against just three hikes), including Russia, Chile, Indonesia and Brazil. The Bank of England and Bank of Japan, however, kept rates unchanged last month — as did the Reserve Bank.

Since the global financial crisis, central banks have carried a disproportionate amount of the burden required to get the developed world back to full employment. The problem is that several major central banks, especially in Japan and the eurozone, are at the limits of what monetary policy can do.

The European Central Bank has pushed rates further below zero and ensured that government yields will continue to trade in negative territory with the resumption of net asset purchases from November.

But with nominal interest rates already below zero and a quarter of all government bonds trading at negative yields, "it’s difficult to see how monetary conditions could become much more supportive", says Capital Economics’ chief emerging markets economist, Neil Shearing.

Additional quantitative easing is an option. However, Shearing points out that there is a growing body of academic work that suggests asset purchases are less effective at stimulating growth and inflation than conventional rate cuts.

Dave Mohr and Izak Odendaal of Old Mutual Multi-Managers agree that developed-country central banks have not had notable success in stimulating growth and inflation over the past decade, nor do they have much firepower left to fight the next recession.

This suggests that if the slowdown in developed-market growth turns into something more serious, it will fall to fiscal policy (tax cuts and expenditure hikes) to do the heavy lifting.

S&P is also pushing the idea of reflation through fiscal policy, arguing that in Europe this would help ensure that central banks don’t have to do more quantitative easing and push rates further into negative territory to lift growth and inflation.

Others are hoping China will come to the rescue with an aggressive fiscal stimulus package, as it did during the 2015 global slowdown. But Barclays expects it to remain more circumspect this time round.

So far, China’s economy has remained resilient in the face of the escalating trade war with the US. But this is mainly due to the outperformance of property construction, a sector that some economists fear may have peaked. Manufacturing and industry have been extremely weak.

This suggests that China’s growth is likely to edge down in the coming quarters. Barclays is forecasting real GDP growth of only about 5% quarter on quarter for China in the second half of the year, from about 6% previously.

"With US stimulus effects fading, Europe’s policy cupboard mostly bare, the drag from tariffs yet to fully hit trade, and China unlikely to ride to the rescue, where will upside growth surprises come from?" it asks.

Certainly not Germany. Simon Baptist, the global chief economist of the Economist Intelligence Unit, has decried the "absurdity" of Germany sitting on the brink of recession with negative borrowing costs yet still resisting using government spending to support the economy.

In contrast, Russia and South Korea are using fiscal policy well in the current environment, he says. Both have reduced their fiscal surpluses substantially to boost growth but, unfortunately, neither is large enough to make a big dent in global demand.

Though Germany has the fiscal space to mount a response, this is less true for eurozone countries with weak balance sheets, such as Italy. It is also doubtful in the US, where President Donald Trump’s tax cuts have pushed up the fiscal deficit in order to sustain the longest-running expansion in US history, now in its 11th year.

Last month, the Fed dropped the policy range 25 basis points (BPS) to 1.75%-2%, as was widely expected, due to soft US inflation and the uncertainty generated by the weak global economy and persistent trade tensions.

"There has been a clear loss of momentum in US industrial production in recent months," says Stanlib chief economist Kevin Lings. In September, the ISM manufacturing index for the US fell to 47.8 from 49.1 in August, reflecting a contraction in new export orders due to the global trade war.

With US stimulus effects fading, Europe’s policy cupboard mostly bare, the drag from tariffs yet to fully hit trade, and China unlikely to ride to the rescue, where will upside growth surprises come from?
Barclays Research

S&P recently raised the risk of a US recession in the next 12 months to 30%-35%. However, Fed chair Jerome Powell stressed last month that the US economy is still in good shape, thanks to buoyant consumer spending and a healthy labour market.

Though Powell said the Fed is ready to act to sustain the US economic expansion, he was careful to avoid the perception that further rate cuts are inevitable.

In fact, five of 17 Fed officials’ latest interest rate forecasts suggest that they believe the Fed has eased monetary conditions too much. This has raised the possibility that US policy rates will remain on hold for the foreseeable future.

The risk, though probably small, is that the market has completely overestimated the extent to which the Fed will cut rates. Disappointment could lead to sharply higher bond yields in developed markets, and capital outflows and weaker currencies in emerging markets, warn Mohr and Odendaal.

Another concern is that extremely low or negative yields could have potentially nasty consequences for financial markets. According to Capital Economics, long-term interest rates and flat yield curves are weighing on banks’ profitability and affecting the ability of pension funds and insurers to meet their obligations.

And while there is not much sign that low rates are fuelling asset price bubbles yet, the risk that they lead to a misallocation of resources and inflate asset bubbles will increase the longer they stay at rock-bottom levels.

A continued global slowdown would make it more difficult for SA to drag itself out of its low-growth trap. This makes it even more urgent that the country undertake structural economic reforms to reduce the cost of doing business and boost growth.

"SA’s economy is already weak due to domestic headwinds," says Shearing.

"A global slowdown is coming at the worst possible time."

The effects will likely be felt in two ways. The first, he explains, is through the weakness of export demand. The second is through lower commodity prices, which would weigh on SA’s terms of trade.

What it means

Central banks are at their limits; it’s all up to fiscal policy now

It’s also possible that a serious downturn or recession — such as would be caused if the US and Iran went to war — could cause a collapse in risk appetite and capital flows to emerging markets.

If coupled with a surge in oil prices, this would hit net oil importers with large current account deficits, like SA, particularly hard.

The bottom line is that despite pockets of resilience, the global slowdown is likely to deepen. While hoping for the best, economists are braced for a no-deal Brexit, worsening trade and geopolitical tensions, and a protracted increase in risk aversion.

Barclays estimates that the global economy will grow 50 BPS slower this year than in 2018 and that 2020 is likely to be weaker still. All is not lost, however. Global labour markets are still in decent shape and consumption should continue to support the world economy, but the risks of a worse outcome loom large.