The global economy: Rising recession risks
The danger of a global economic downturn has risen, but the probability of a recession in 2019 is still low. After a brief spurt in 2017 and 2018, growth in the G7 economies is reverting to trend, and emerging markets are unlikely to come to the rescue. This process is likely to be delayed in the US economy because of fiscal stimulus; however, higher tariffs, financial volatility, and the government shutdown will hurt growth-the only question is how much. The good news is that US consumer spending is on solid footing. However, elevated political risks in Europe are beginning to darken the outlook. Moreover, China's growth is proving to be especially fragile, and data for the last seven months show a marked slowing of activity-the industrial sectors are close to recession. Policy mistakes, especially regarding trade, continue to be the biggest threats to global growth. Fiscal and monetary policies have little room to stimulate in the event of a downturn.
United States: Real GDP growth was reported at an annual rate of 3.4% in the third quarter of 2018, and IHS Markit expects fourth-quarter growth of 2.8%. However, recent turbulence in financial markets has softened the outlook for 2019 and beyond. In response, we have removed one Federal Reserve rate increase from our forecast and lowered our projection for US Treasury yields. Combined with other developments, the net effect was to reduce our forecast of real GDP growth by an average of 0.1 percentage point per year from 2019 through 2022. We made no explicit adjustments to the January forecast to reflect the partial government shutdown. Assuming the shutdown lasts three weeks into January, we estimate first-quarter growth will be cut 0.1 percentage point, and losses will be recovered in the second quarter.
Europe: Growth is headed lower in 2019. Eurozone real GDP increased a disappointing 0.2% quarter on quarter (q/q) and 1.6% year on year (y/y) in the third quarter of 2018. Gauging the underlying growth trend has been complicated by a series of distortions, including the emission-test-related slump in automotive output. An expected rebound there, plus the fiscal stimulus coming in Germany, France, and Italy, will lead to a temporary pickup in real GDP growth to 0.5% q/q in the first quarter of 2019. The IHS Markit forecast calls for just 1.4% growth in 2019 and 1.2% in 2020, with risks still to the downside. Meanwhile, recent data and the UK parliament's rejection of the Withdrawal Agreement support our cautious near-term UK growth projections. We expect UK real GDP growth to slow from 1.3% in 2018 to 1.1% in 2019.
Japan: The sales tax hike will cloud the outlook for 2019.<span/>Real GDP declined at a 2.5% annual rate in the third quarter. Available data suggest real GDP recovered in the fourth quarter, thanks largely to a rebound in domestic demand. However, net exports were likely a drag on fourth-quarter growth as imports increased more rapidly than exports. Real GDP growth is expected to hold steady at 0.8% in 2019, slip to 0.5% in 2020, and rise to 0.7% in 2021. The scheduled increase in the sales tax from 8% to 10% in October 2019 will contribute to volatility in quarterly growth patterns, as consumers and businesses shift purchases forward.
China: More signs of fragility. Following the trade truce reached by the president of the United States and the president of China, Donald Trump and Xi Jinping, we have assumed that US import tariffs on USD200 billion of Chinese goods will remain at 10% rather than increasing to 25%. Economic growth should stabilize as the government releases additional stimulus, including corporate tax cuts, credit easing, infrastructure investment, and looser real estate rules in lower-tier cities. Meanwhile, exports, industrial production, and retail sales have decelerated, as has factory price inflation. The balance between weak data and expected further stimulus leaves the IHS Markit assessment of China's near-term outlook unchanged.
Other large emerging markets: While currency pressures have eased, the outlook is not that bright. The pressures on emerging-market currencies have eased considerably, compared with the first half of 2018. Further pressure relief can be expected as the Federal Reserve takes an even more cautious approach towards raising interest rates. That said, weakening global growth and more pessimism on commodity prices will do little to boost growth prospects even among the star performers. Growth is expected to be lackluster (or even worse) in other large emerging markets such as Russia, South Africa, Turkey, Brazil, and Mexico. In the latter two countries, uncertainty about the policies of new governments is also giving both domestic and foreign investors pause. All this means emerging markets will not be able to offset the weakness in developed markets.
Bottom line: Growth is slowing everywhere, but it is far too soon to run for the exits. Barring a policy or other type of shock, the world economy is likely to muddle along for at least another year.