Renewed trade dispute casts shadow over global economy

• Re-escalation of the trade war between China and the US and weakening market confidence are weighing on the global economic outlook.

• As a result, we have lowered our projections for global growth to 3.2% in 2019 and 3.4% in 2020 (from 3.6% and 3.5%, respectively).

• We see a modest recovery on the back of a trade deal between the US and China in H2 2019 and further stimulus measures by China and US central banks.

• However, risks are skewed to the downside given the possibility of no China-US trade agreement (or even possible further escalation) and lack of timely policy action.

• The risk of a recession over the next year is, in our view, still relatively low given the room for central banks to ease and fiscal expansion amid low government yields

Global economic momentum weakening...

The moderation in the global economy in the first half of 2019 that we called for in Big Picture – No recession yet, 4 December, has indeed materialised. However, the downturn has been deeper than we thought. Financial markets confidence took a sharp dive in December following the softening outlook for the global economy and uncertainty about the trade relations between the US and China. The slowdown has been evident in manufacturing PMIs, mainly in advanced economies, which have fallen, in particular, for the eurozone, albeit coming off of high levels.

In response to the weakening momentum in the global economy and sharply declining inflation expectations, major central banks reacted at the beginning of the year. The Federal Reserve in the US lowered its rate expectations from two hikes in 2019 to no hikes and expecting only one hike from two hikes next year. The ECB announced new liquidity operations (TLTRO) and extended forward guidance in March. These efforts together with policy stimulus in China in H2 18 stimulated recovery in global risk sentiment in Q1.

...with renewed stand-off between US and China further challenging global outlook

In early May, the trade dispute between China and the US took a turn for the worse after President Donald Trump decided to increase tariffs from 10% to 25% on another USD200bn of imports from China. The US move was prompted by concerns about backtracking on the deal from the Chinese side. China retaliated immediately by levying tariffs on US exports. The new trade tensions throw into doubt the prospects of the two sides finding an agreement. However, we still think there is a good chance of an agreement in second half of 2019 but possibly only after a substantial deterioration in market sentiment and possible further trade war escalation with US imposing tariffs on the remaining USD300bn of imports from China over the summer (we see 50% chance of such action).

The uncertainty prompted by renewed trade tensions between the world's two biggest economies will weigh on sentiment. As a result, we see further downside for PMI manufacturing in coming months, mostly in China but spilling over to the eurozone and other close China trading partners such as Japan and Australia.

As a result, we lower our global growth forecasts

Given the heightened uncertainty and delays in finding a China and US trade agreement, we lower our outlook for the global economy, expecting it to grow by 3.2% in 2019 and 3.4% in 2020 compared with 3.6% and 3.5%, respectively, in Big Picture – No recession yet, 4 December. The eurozone and emerging markets such as India, Turkey and Latin America are the main factors behind the downgrade.

In late 2019, we expect the global economy to see a modest recovery due to a recovery in investment and private consumption on the back of a trade deal between the US and China and monetary stimulus measures in China and the US. This recovery will carry into 2020 aiding especially the eurozone and emerging markets and partly benefting from a weaker US Dollar and easier global liquidity conditions.

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