Global Economic Outlook: Mild Recession orWeak Recovery?

As the new year approaches there are many concerns about the prospects for the global economy after a difficult year. There has been no obvious bright spot in the global economic performance. Instead, there have been several lingering questions about what lies ahead.Among them, is a global recession around the corner? How will negative interest rates affect the monetary policies of major central banks? How will Brexit and the Sino-US trade war play out? Will the major world economies reach a basic consensus to maintain broad stability and gradual improvement in global governance when globalization is being seriously challenged? And will these already complex issues become even harder to deal with in the coming year?

Zhong Wei

Lin Caiyi

Zhong Zhengsheng

At a roundtable discussion organized by China Forex, Lin Caiyi, chief economist of HuaAn Funds, and Zhong Zhengsheng, chairman and chief economist of CEBM, Caixin Insight, shared their opinions on the prospects for the global economy. The conversation, which follows in edited form, was moderated by Zhong Wei, China Forex deputy editor.

01

Zhong Wei: Welcome to this roundtable discussion. In late 2018 and early 2019, major international institutions were gloomy about the prospects for future economic developments.Experts believed that under the influence of recession and mounting inflation global economic growth would be disappointing. Major central banks would be pushed to resume quantitative easing and begin another cycle of interest rate cuts. With the passing of time, however,some institutions have revised their expectations. The IMF,for instance, now expects that economic growth in both the developed and developing countries will be slightly better next year than in 2019. In your opinion, what new factors have contributed to this cautiously optimistic outlook?

Lin Caiyi:There are three major factors that account for the improved outlook. First, the impact of trade disputes provoked by the United States has gradually been absorbed as far as the real economy and market expectations are concerned.Second, the deflator for core personal consumption expenditure (PCE) has continued to rise and China’s PMI and CPI have been on an upward trend. The prosperity index and corporate profit data are starting to reflect the positive results of an improved business environment due to cuts in taxes and administrative fees. Additionally, the US Federal Reserve’s expansion of its balance sheet in the fourth quarter of 2019,along with China’s easier credit policies, all point to economic improvement in 2020.

Zhong Zhengsheng:The cautiously optimistic expectations for global economic growth are the result of the following factors:First, global monetary policy has been relaxed further. The Fed has cut interest rates three times in this cycle and the European Central Bank, at its September meeting, cut its deposit interest rate by 10 basis points to -0.50%.The ECB also resumed its asset purchase program. Monetary growth in the US and Europe is stabilizing and China’s social financing has seen steadier growth since the first quarter of the year.Expectations for more financial stimulus have also intensified.

Japan has already launched fiscal stimulus programs while there are further efforts for stimulus in Germany, the locomotive of the European economy. And China’s large-scale tax and administrative fee cut also has begun to show positive results.The service sector is relatively stable. Since the beginning of 2019, global manufacturing encountered a significant setback as the PMI of all major economies dropped below 50, the level showing economic contraction,even though the service sector held steady. Structural changes within the service industry itself might be the major contributing factor for this result. Meanwhile,services related to manufacturing still had rapid growth. And Sino-US friction is expected to ease as the two sides say they are about to agree on a phased trade deal. More frictions are not likely to emerge until at least the US presidential election is held next year.

02

Zhong Wei: Early implementation of macrocontrols enabled a smooth start for China’s economy in 2019,though economic growth still lost momentum over the first three quarters of the year. Countercyclical policies gradually took effect, and expectations for growth in the fourth quarter improved. China’s economy has encountered new challenges this year, such as the impact of pork prices on the consumer price index as well as a decline in auto sales, as well as volatility in Sino-US trade relations. What are your expectations for China’s economy in 2020?

Lin Caiyi:From the perspective of overall development trends, the upgrading of consumption is the core driving force of China’s economy. The real estate sector is not likely to see much of an upturn and auto demand has also stagnated. In first and second tier cities, demand for autos has been constrained by traffic bottlenecks.Moreover, consumption data suggest that the growth in demand for education, health care, entertainment,as well as leisure and other services is likely to be much faster than demand for clothing and food.

Interest rate reforms such as the implementation of the benchmark lending rate – the loan prime rate – have helped make rates more market-based. Since August, corporate lending,especially medium and long-term loans, have increased at a quickened pace. In September, the growth of the overall stock of enterprise financing rose 7.6% from 7.1% previously and M2 realized a year-on-year increase of 8.4%, benefiting from an increased supply of credit. Fiscal support for the economy expanded and as a result fiscal deposits fell more than 700 billion yuan in September from a year earlier, doubling the year-on-year decline recorded a year ago.

As for businesses, the indexes for enterprise profits and overall business conditions began to respond positively to tax cuts enacted in the second quarter. Aided by easier credit policies,most enterprises will have better operating conditions by the end of 2019.

In sum, economic growth in 2020 will continue to trend moderately lower, but there will be a number of areas where support for the economy will be apparent.

Zhong Zhengsheng:China’s quarterly GDP growth rate could slip below 6% in 2020, but that is no cause for alarm. Let’s look at it from the perspective of the economic cycle. Currently,inventories of finished goods at enterprises above a designated size are only 2.2%, which is already quite close to the historical low of 1.9%. Added value growth in most industries is below onethird of the historical average and room for further production cutbacks is limited.

China’s efforts to upgrade its economy have been accelerated by a steadily rising role of the service sector coupled with greater industrial concentration. In recent years, emerging services such as big data and the “Internet of Things” have had significant positive spillover effects on productivity. From a policy level,compared with major Western countries, China’s monetary and fiscal policy space is sufficient and closer to“normal” levels.Making appropriate use of this at the right time will help ensure a healthy economic performance.

Additionally, with the introduction of support systems and measures to improve market access, a new round of reform dividends can be expected. One area where this is expected is the capital markets. With the decline in the annual fixed deposit rates in developed economies, returns on renminbi assets will be comparatively more attractive. Foreign purchases of renminbi assets will gather pace. All of these factors will lay a sound foundation for the recovery and development of the real economy.

03

Zhong Wei: In 2019, concerns over growth and inflation drove a worldwide trend towards negative interest rates. Major central banks also resumed quantitative easing policies.The renminbi exchange rate weakened to more than 7 yuan to the US dollar this year.Moreover, even though the US Fed has denied it has begun another round of rate cutting, it has resumed purchases of shortterm US Treasuries, or what has been referred to as QE 4.0.The European Central Bank has implemented negative interest rates and begun more asset purchases. Yi Gang, governor of the People’s Bank of China, has an interesting interpretation.In his mind, major economies which can maintain normal monetary policy, especially at a time when policy space is shrinking, are bright spots in the global economic picture and deserve some praise for their accomplishments. Judging from the actions of the world’s major central banks, what are your views as to the trend for major currencies in 2020? Will the US dollar remain in a dominant position?

Lin Caiyi:Monetary easing will be the theme of global monetary policy in 2020. Bearing this in mind,most bond yields will decline and as a result, renminbi bonds will attract more investors from the international market. What’s more, in the context of negative interest rates and low economic growth in many countries,China’s continuous opening up of the industrial sector is likely to attract overseas capital. Demand for the renminbi might increase on foreign exchange markets, and this could be a key factor in ensuring a steady renminbi exchange rate in 2020.

Regarding the US dollar, the Fed resumed its overnight repo activities on September 17th – the first such action in a decade.The end of the balance sheet shrinking also terminates the upward cycle in interest rates.The Fed’s expansion of its balance sheet from the fourth quarter of 2019 through the first half of next year will further lower US interest rates. Accordingly, the US dollar’s stronger trend will come to an end. In Europe, the uncertainties and unfavorable situation for both sides in the Brexit situation will weaken the euro and the pound.

Zhong Zhengsheng:The US dollar encountered significant volatility this year.The US economy also shows more signs of weakening, and that means the dollar’s dominant position might change. The IMF forecasts a narrowing of growth differentials between the US and Europe in 2020 (real US GDP growth will fall from 2.35% in 2019 to 2.09% in 2020, while Europe will see a slight increase from 1.16% to 1.39%).

In contrast, the renminbi exchange rate might strengthen. On one hand, foreign capital will be shifted into more renminbi assets and inflows under the capital account should remain strong. There will be an acceleration of the opening up of China’s financial market amid negative interest rates in some overseas markets. There will be a weaker correlation between US and Chinese assets, and the renminbi will have greater prominence in global asset allocations.Meanwhile, according to Markit, China’s manufacturing PMI has rebounded since the second half of this year and is significantly better than the global average. This also reflects less pessimistic expectations for China’s economy. In fact, China’s economy is more likely to grow at a faster pace as a result of increased efficiency.

The IMF forecasts a narrowing of growth differentials between the US and Europe in 2020.

04

Zhong Wei: Assets overall showed a sharply divergent track record in 2019. Commodities had little traction, while gold began a decline in August after surging earlier in the year. The US stock and bond markets managed gains despite strong turbulence, while China’s stock market became more resilient. With the deepening of market-oriented reforms and the acceleration of China’s financial market opening, China’s stock and bond markets have attracted more and more foreign capital. Meanwhile the global real estate market has remained in a depressed state. In your view, what new changes can be expected in general asset allocation if the global economy recovers slightly amid greater liquidity?

Lin Caiyi:The rise in the price of gold in 2019 was mainly due to volatility in the international political and economic situation. In 2020, the main factor supporting the price of gold would be the downward trend in US interest rates. However, after surging 30% this year, there is little room for gold to climb further.

Additionally, oil demand is slackening.Technological progress, such as shale development, means that an abundant supply of crude oil will be the norm,assuming there are no fresh geopolitical shocks. Ultimately, the price of oil in 2020 will largely depend on the geopolitical situation in the Middle East and Russia.

In terms of investment opportunities in stock and bond markets, bond yields in 2020 will be higher than this year. However, under the influence of Sino-US friction and other trade disputes, the road ahead for the stock market is quite unclear.

Zhong Zhengsheng:US stocks will continue to be desirable assets.In 2020, the market expects a more significant improvement with earnings per share growth to reach 10.4% for the S & P 500 and 18.6% for the NASDAQ. If the global economy can manage a slight recovery in the coming year, earnings could be an important variable in supporting US stocks. Longer term US debt still has no particular trading value for the time being, even if there are no major risk events. However, the yield curve of US debt may steepen again.

After an upturn in yields on longer term bonds, gold will see its price constrained. Nevertheless, as a hedging tool, gold still has its value in overall asset allocation, especially when there are so many negative yield assets. These have already exceeded US$16 trillion and account for more than 27% of global sovereign debt.

The market has greater appetite for risk assets as a result of easing concerns about China’s economy and signs that the US and China might find some way to avoid further damage in their prolonged trade spat.This has also strengthened interest in renminbi assets. The role of renminbi assets in global asset allocation will therefore rise steadily.

05

Zhong Wei: At the beginning of 2019, there was much speculation that this would be a year of “black swans” and “gray rhinos.” We now see that in spite of the friction between China and the US, concerns about Brexit and worries of fresh turmoil in the Middle East, there have been no major disruptions.In your opinion, what potential black swan events might occur in 2020? What tactics might we see to avoid or respond to these?

Lin Caiyi:A plunge in US stocks would be the biggest black swan event in 2020. After a decade-long bull run,US stock valuations are high. Another possible black swan would be a political event in the Middle East. A sudden surge in oil prices resulting from geopolitical conflicts would result in a shock to global economic growth and global stock markets.

As for gray rhinos, at the top of the list would be Trump’s “America first” policy and trade protectionism in general. The global economic and trade landscape are already being reshaped. Movements opposing globalization and a tilt towards rightwing politics will be the inevitable result. The world’s political economy will gradually enter a “post-Western era.” The second gray rhino is Brexit.This irreversible break-up will certainly have negative effects on both the UK and the EU economies and ultimately affect the foreign exchange and stock markets.

Zhong Zhengsheng:I will just offer a few examples. The first black swan would be a Trump electoral defeat. The US presidential election will be one of the most important events of 2020. For now, there is a good chance that Trump will be re-elected even though he faces serious challenges. The second is that populist movements in Europe intensify in 2020. The third is the eruption of another European debt crisis. The debt problems of Italy,Greece, Spain and other southern European countries are still serious,and the possibility of another debt crisis should not be overlooked.

There are good reasons for cautious optimism towards economic growth in 2020.

Zhong Wei: Thank you both for joining us. You have pointed out that there are good reasons for cautious optimism towards economic growth in 2020. We should have reduced concerns about a global recession. For China, quarterly GDP growth could possibly dip below 6%.The renminbi is expected to be relatively strong and steady,while China’s stocks and bonds will have more international appeal. Regarding US stocks and gold, Dr. Lin holds a more pessimistic view, while Dr.Zhong is relatively optimistic.And finally, in 2020 we expect the US dollar to move away from center stage.