US/China trade headwinds will continue to be a drag

From

David Lafferty

US/China trade headwinds will continue to be a drag on global growth. In isolation, very small effect on the US, larger on China. However, the cross-over effects to manufacturing will be felt the longer it lasts.

Manufacturing/industrial weakness could eventually spill over into labor trends and then the US consumer would be affected. Uncertainty will continue to weigh on capex and business spending. I expect a future deal between US & China won’t mean much.

Central banks are effectively out of ammunition even if they are not nominally out of ammunition.  Central banks may do more, but it won’t help much. Most of the positive effects of extraordinary monetary policy have already been realised. Global monetary stimulus is unlikely to boost real or nominal growth much in the intermediate future.  Extraordinary policy may have been able to keep things from getting worse, but there is little evidence that it has created a growth impetus. The loosest financial conditions in history (2008 – now) have been associated with the slowest recovery and expansion in history (as measured by US GDP).

Fiscal policy as a lever for long term growth is impaired throughout the world, but by different factors in different countries:

  • In Europe, that includes budget rules in Germany, EC constraints on France and Italy, etc.
  • In the US, fiscal policy is hampered by political grid-lock. US tax stimulus (2018) was a direct result of Republican clean-sweep in 2016 (President, House, and Senate). However, Republicans no longer hold the House of Reps and are unlikely to re-take control in 2020. Meaningful US gov’t spending now requires bi-partisan support, and that is very rare.
  • China’s fiscal space is constrained by skyrocketing debt (much of it pushed down to local or regional gov’t level). They are actively seeking to slow fiscal expansion in the long run. The short run may be looser as policymakers seek to offset the US trade war effects.
  • Japan has limited fiscal space and is moving in the other direction with the upcoming sales tax increase
  • The longer term trend in developed markets is toward convergence to “potential GDP.” This is my broad macro outlook, but with the risk of US/global recession at about 35%. Rising, but not my base case, which is “slowing to long-term (i.e., potential) trend growth.”

As for the determinants of long term growth, I typically employ a supply side view.  Longer run potential GDP = Productivity growth X Labor Force Growth.  All of these would argue for a “slower for longer” outlook.

Organic labor force growth (birth rates) is slowing in developed and emerging countries, a natural byproduct of increased wealth and birth control.  (Labor force participation rates play a role too, but that trend is mixed in the US across factors like race, age, gender, etc.)

Non-organic labor (i.e., immigration) is slowing due to anti-immigrant sentiment (Europe, UK/Brexit, US/Trump). Falling labor force mobility can’t get workers to their highest and best area of employment.

Productivity is more of a mystery, but the data would argue it has slowed post-GFC. It is often associated with innovation, technology, capex, and the capital stock. In the US, the capital stock is old and capex has generally been weak in recent years. Uncertainty around trade wars and fears of “secular stagnation” hold back capex and investment, impairing productivity growth. (Is this circular logic or a self-fulfilling prophecy: Fear of slow growth => CEOs hold back investment and capex => Contributes to slower growth???)

In summary, I think longer run growth determinants would argue for slower for longer.

As measured by demand/consumption: Weak investment spending (business uncertainty), weak gov’t spending (gridlock, budget rules, debt ratios, etc.), and a weak external sector (trade wars). The global consumer is doing OK, but the other drivers are likely to remain soft.

As measured by supply-side factors: Weak labor force growth X weak/uncertain productivity growth.

By David Lafferty, Chief Market Strategist

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