Not everybody agrees with the U.S. Federal Reserve’s view that the U.S. economy is generally on the upswing, Europe is not that far behind, and the emerging markets are currently just in a bit of the doldrums. Some economic pundits have begun using the “R” word again, suggesting that the ongoing market meltdown in the new year reflects more than just an over-reaction to plunging oil prices and a slowdown in China, and that there is a growing risk of a global recession.
In their January 19th report, Morgan Stanley Co-Heads of Economics Elga Bartsch, Chetan Ahya and team argue that “growth has been sputtering lately. Our base case was for modest but below trend global recovery. But the risks are skewed to the downside and appear to have risen recently.”
Consumer demand dropping in developed markets?
The MS team begins by admitting that their “key assumption” that developed market domestic demand would remain strong has been thrown into doubt by the U.S. economy stagnating in the fourth quarter of last year given less than expected consumer spending, slipping business investment, notable inventory adjustments and headwinds from net trade figures.
Bartsch and Ahya are still calling for DM domestic demand to stay reasonably strong for the net few quarters and argue that “the drag from EM will reduce slightly in the course of 2016.” That said, they also note that some economic data are suggesting “rising risks that DM domestic demand, in particular in US and Japan, might weaken more than our earlier expectations.”
If DM consumers stop buying, even for a little while, the odds of a global recession increase dramatically.
Emerging markets still face considerable headwinds
The thesis that emerging markets would begin to recover in the near future is also in serious doubt as global commodity prices continue to drop and higher capital outflows are continuing to pressure the Chinese RMB (and many other EM currencies). The impact of the slowdown in China on the economies of other emerging markets is evident, but the Chinese economy seems to have stabilized at around 6 yoy growth for now.
The MS report also highlights that the growing “credit gap” and the expanding debt service ratios in China, Brazil and Turkey are issues of concern both the central banks of these countries ad the global economy.
What can central banks do to stem the tide?
Central banks not been shy about acting to mitigate downside risks to growth over the last few years, and this trend seems likely to continue.
Given the unwinding of leverage in both DM and EM, the slow recovery and minimal inflationary pressures, it is probable that monetary policy stance will remain accommodative in most countries.
Related to this, Bartsch and Ahya argue the U.S. Fed won’t hike rates again until June 2016, given minimal “actual progress” toward the Fed’s 2% inflation goal. That said, they do project two 25bp hikes in the second half of the year as the economy picks up steam.
The MS report also calls for further easing from EM monetary policymakers. They anticipate the PBOC (China) will reduce rates by 25bp a couple of times in 2016, RBI (India) to cut by a quarter point, and Russia to slash rates by 200bps by the end of 2016.
Economic growth forecasts show growing chance of global recession
It seems likely that global GDP growth dropped to below 3% in SAAR terms in the fourth quarter compared to 3.3% in the third, and could have dropped as low as 2.5%. The slowdown is mainly related to slowing domestic demand in the U.S. and continued weakness in manufacturing worldwide. Plunging oil prices and more pain in the energy sector have further contributed to the economic malaise, and further drops could be the straw that breaks the camel’s back and leads to a global recession.
Nartsch and Ahya highlight that U.S. GDP has slipped to neutral, and note real risks to their projections for Japanese and UK growth. Eurozone growth, however, is largely on track, with a 1.6% SAAR.
Global recession worries notwithstanding, the MS team maintains their call for “moderate improvement in global growth to 3.3%Y in 2016,” but also says “Risks to our view of a slow recovery remain skewed to the downside and might have indeed emerged sooner than expected.”