Global economic outlook: Trump’s threats spoil sentiment at the family dinner

20 June 2018 11:26

The economic outlook for the global economy remains positive, but risks of a correction have increased sharply as a result of increasing trade tensions. Geopolitical risks and vulnerabilities in various emerging economies are also worrying.

Global growth is around 4 per cent, as long as …

Global growth will remain on track in 2018 and 2019 compared to last year (table 1, figure 1). The global outlook is thus more or less the same as that described in our previous Economic Quarterly. We are however adjusting our forecasts for various economies to some extent. We see slightly higher growth for countries including the US, Australia and New Zealand, while we are adjusting our forecasts for the Eurozone and Brazil among others to the downside.

Table 1: Economic prospects for the major economies

Source: Rabobank, Macrobond, IMF

The US, the Eurozone, the UK and Japan all appear to be at or near the end of their business cycle. We note that what is known as the output gap (the difference between current and potential GDP growth) has already been closed (figure 2) for the US, Eurozone and the UK. A positive or very positive output gap[1] means that production is above potential and therefore that inflationary pressure is increasing. Growth in these economies will therefore gradually ease to the level of potential growth in the coming years. Rising inflation moreover means that the central banks will (further) tighten monetary policy. This is a major factor in our forecast that growth will not rise further compared to last year.

One important observation is that the uncertainties surrounding the global economy have increased. Trade tensions have intensified further in the past period, several emerging markets are facing serious challenges and there are various latent geopolitical issues, all of which could mean that global growth will turn out to be lower than we currently expect. We will begin with these uncertainties before taking a world tour.

[1] The output gap cannot be measured exactly, it can only be estimated. There are sometimes significant differences between the estimates of policy institutions (Weernink, 2014).

Figure 1: Growth stabilizes this year and next

Source: Rabobank, Macrobond, IMF

Figure 2: Output gaps in the developed economies

Source: IMF

Trade tensions intensify further

The United States is pursuing its protectionist policy on trade with increasing vigour, raising the risk of a correction in world trade. The US imposed import duties on steel and aluminium from Europe, Canada and Mexico with effect from 1 June. These countries have already announced countermeasures. In addition, on June 15, the US announced tariffs of 25 per cent on 50 billion US dollars of Chinese goods. This involves 1.102 Chinese products. The introduction will take place in two rounds, with the first round of 34 billion US dollars (818 product groups) starting on 6 July. The remaining 16 billion dollars (284 product groups) will be introduced at a later date, and a public consultation will take place first. Most of the products that the US targets are related to high-tech sectors that are part of the ‘Made in China 2025’ plan, such as aerospace, information and communication technology, robotics, industrial machines, and (green) cars.

Immediately after the announcement of these protectionist measures by the US, China indicated that it would retaliate with the same magnitude. The US therefore also faces two rounds of Chinese tariffs on US imports worth 50 billion US dollars. The first round of another 34 billion dollars will also take effect on 6 July and consist of 25% tariffs on agricultural products (such as soybeans, corn, wheat, beef, pork, poultry) and various types of vehicles. The second round of 16 billion dollars will cover the import of chemicals, medical equipment and energy related products, such as coal and crude oil. Trump responded again on 19 June with a new threat: he ordered his civil servants to identify another 200 billion US dollars of imported goods from China on which new tariffs could be levied. Actual implementation of this measure takes time, and that time can be used by both parties to reach a deal. But a US-China trade war comes dangerously close with these latest developments.

Box: Consequences of a trade war

US protectionist measures and countermeasures by the affected countries are currently targeted at specific sectors. In macroeconomic terms, direct damage is still limited. However, they can be the prelude to a global trade war, which would be very damaging to the world economy.

The precise effect of the current measures is currently difficult to quantify because the tariffs vary for different product categories. This also applies to any negative side effects in the real economy, such as rising unemployment and lower private consumption levels. In order to make an exact calculation, we should ideally use a general equilibrium model that takes into account the current level of tariff and non-tariff measures for each product category. However, this is a time-consuming task and for the purpose of this publication an indication of the effects of the current tariff packages is sufficient. The calculation method and reservations for this can be found in this Special.

For the EU, we have calculated that the US steel and aluminium tariffs of 25 and 10 per cent respectively will have a limited negative macroeconomic effect. For countries like Canada and Mexico, however, the grapes are sour, because trade with the US is relatively important to them. Our calculations show that Canadian economic growth could be a third lower due to the tariffs and for Mexico the economic damage could be roughly one fifth. As mentioned, the steel and aluminium tariffs also increase the risk of further escalation. Trump has already indicated that he will consider tariffs on the import of foreign cars. Finally, negotiations on the renewal of the North American trade agreement NAFTA have been damaged by Trump's protectionist measures.

The latest US tariffs on Chinese imports may result in some Chinese exporters losing 60 percent market share in the US. Because China is retaliating with the same magnitude, American exporters of affected products might lose 54 percent market share on the Chinese market. For large economies such as China and the US, the negative GDP effects of these packages are still limited, but by 0.2 and 0.13 percentage points, respectively, a lot more than the steel and aluminium tariffs and the related retaliatory measures. This only concerns the direct effect via export volumes. Indirect effects are not included.

Challenges for emerging markets increase

Apart from the rise in protectionism, emerging markets are also facing other issues that could reverse their growth, or their growth prospects, mainly because strong economic growth and rising interest rates in the US contribute to an outflow of capital from emerging countries. A stronger US dollar will in turn increase the cost of servicing existing dollar debt in these countries. And there are also country-specific factors that play a part. Countries that are dependent on oil imports (see below) are suffering from the volatility in oil prices. Total capital outflow from emerging markets amounted to a staggering 12.3 billion dollars in May, the highest figure since the end of 2016. As a result, various emerging markets currencies have declined substantially in value since the beginning of 2018 (figure 3)[2].

Countries with high levels of debt in foreign currency combined with so-called ‘twin deficits’ are especially exposed to external shocks (figure 3), such as Argentina and Turkey. A ‘twin deficit’ refers to a deficit on the current account of the balance of payments and a government budget deficit. Countries in this position are forced to raise foreign capital in order to finance their spending. Shocks such as an unexpected rise in US interest rates or oil prices will cause heavy pressure on the balance of payments and government balances, increasing the likelihood of a crisis in these countries. This is why Argentina has now turned to the IMF for a support package amounting to 50 billion dollars.

[2] Country codes in sequence: ID (Indonesia), TH (Thailand), PH (Philippines), IN (India), MX (Mexico), KR (South Korea), TR (Turkey), ZA (South Africa), MY (Malaysia), PL (Poland), BR (Brazil), AR (Argentina), CN (China), EG (Egypt), CL (Chile).

Figure 3: Pressure on emerging markets

Source: Macrobond

Geopolitical situation continues to pose unprecedented challenges

Finally, there are various geopolitical developments that pose a downside risk to the current economic situation. The unilateral cancellation by the US of the nuclear deal with Iran has contributed to added upward pressure on oil prices (figure 4). If geopolitical tensions increase further, oil prices could become more volatile. In a recent study we show that oil-importing countries will suffer most from an oil price shock, such as India, Turkey, South Africa and Vietnam, especially in combination with the increasing challenges facing these emerging markets we describe above. And although the risk of escalation as a result of the recent summit between North Korea and the US has decreased, this is also an important latent geopolitical risk. China also plays an important role in this situation. This also applies to tensions around Taiwan and in the South China Sea where both China and the US are involved.

Given all these uncertainties, the forecasts for the major economies listed below are inevitably conditional on further developments.

Figure 4: Brent oil price nears USD 80

Source: Macrobond, Rabobank

United States: could the ship run aground?

The US economy has been growing strongly for some considerable time, and we expect this to continue this year and next year as well. The labour market is tight, which is having a mildly positive effect on wages. Inflation is also picking up, allowing the Federal Reserve to raise interest rates further. But low unemployment and higher wages will enable households to maintain their level of consumption. At the same time, Trump’s tax cuts this year are encouraging high investment by businesses. The other side of the coin is a rapidly increasing budget deficit, which means the government has little room to invest in infrastructure.

This positive picture of the US economy is beset by ever-increasing uncertainties. In particular, the rising trade tensions with China, Canada and Mexico and the EU are a cause for concern. Trade-restricting measures will also negatively affect the US economy. There are also signs in the domestic economy that we could be approaching a turning point. We see a controlled return to growth of around 2 per cent as the most likely scenario, but there are also indicators that could point to a hard landing. Higher defaults on car loans for instance suggest that households are having more difficulty in making ends meet. And the flatter government bond yield curve means that investors have less confidence in the short term outlook for the economy.

The Eurozone has passed its growth peak

The Eurozone surprised last year with growth that exceeded the rate seen in the US, and continued to surprise at the beginning of this year – this time with a disappointing first quarter figure. Was this first quarter of 2018 simply a false start, or a sign of worse times to come? We think that things will turn out all right. Yes, we are seeing economic growth recede somewhat in the Eurozone this year, but overall growth is broadly supported by all the Member States.

United Kingdom: if only Brexit was already behind us …

The UK economy is suffering, mainly from the uncertainty surrounding Brexit. British consumers have seen their purchasing power decline due to the depreciation of the pound since the Brexit referendum. The inflationary effect of this is now however subsiding. Tightness in the labour market is also supporting households through rising wages in real terms. But this tightness, together with high production capacity utilisation, is placing limits on economic growth. And uncertainty around future trade relations with the EU is making businesses cautious with respect to investment. Economic growth will weaken further this year and next, and we do not expect to see a low point reached until 2020. The Bank of England has the thankless task of finding the right pace at which to combat inflation without putting too much of a brake on what is only moderate growth.

Japan: a false start to 2018

The Japanese economy had a weak start this year. Growth in the first quarter contracted by 0.2% compared to the previous quarter, bringing an impressive series of 8 successive quarters of GDP growth to an end. Although we expect to see a recovery in the second quarter, this weak first quarter will mean that growth will be lower this year than it was in 2017. Domestic growth will be supported by government stimulation and continuing loose monetary policy from the central bank of Japan. On the other hand, increasing capacity shortages mean that there will be limits to this. Any US tariffs on Japanese cars could also be fatal for exports: 20 per cent of Japanese exports go to the US, with nearly a third of exports consisting of cars. So Japan too is exposed to the risk of rising protectionism.

Australia and New Zealand: exceeding expectations

The Australian economy looks to be in a cyclical growth acceleration, and we have adjusted our forecast for this year slightly to the upside. The acceleration is driven mainly by domestic consumption, from both households and the government. Given the level of their spending, households are as yet not feeling the effects of government measures designed to cool the housing market. The government will also have little incentive to curb spending in the run-up to elections next year. In the longer term, Australian interest rates will follow US interest rates, which will have a dampening effect on investment and consumption, and economic growth will moderate to some extent.

In New Zealand as well, growth seems to be picking up on the back of continuing demand from China, decent prospects for the meat and dairy sectors and continuing net migration (which contributes to population growth). In the longer term however, the cooling housing market, protectionist measures from the government and rising interest rates will mean that economic growth will weaken.

Emerging economies: India and China in the lead

The Chinese economy grew significantly faster than expected in the first quarter, posting growth of 6.8 per cent compared to the same quarter last year. The target of GDP growth of around 6.5 per cent for this year is therefore already within reach. This means that the policy focus can shift further to what is known as the quality of economic growth. The big question is what will happen if the inevitable slowing of domestic growth is more serious than expected, due for instance to increased financial instability or a correction in trade as a result of rising tensions with the US. In this case, there is a possibility that China will boost the economy through higher government investment and monetary stimulation, which would mean that the current domestic risks and imbalances would not be mitigated.

India continues to post strong growth figures, with domestic demand currently amply compensating for the negative contribution to growth of net exports. India actually posted the highest growth of all the leading emerging markets, at 7.7 per cent in the first quarter. We expect India to continue to grow at this rate in the coming years, even though its external vulnerabilities have increased. India is exposed to higher US interest rates and higher oil prices, also due to its current account deficit (see also above).

The Brazilian economy gradually emerged in 2017 from a deep recession in previous years. This recovery will continue at a moderate pace in 2018 and the years to come, as long as the presidential elections at the end of this year lead to a market-friendly administration. The underperformance of the economy at the beginning of the year relative to expectations was partly due to uncertainty regarding the outcome of these elections. We have accordingly adjusted our growth forecast slightly to the downside. Higher oil prices and a depreciation of the Brazilian real have already led to a sharp increase in the cost of petrol, leading in turn to a disruptive strike by truck drivers. A new administration will face the challenge of bringing the budget more in balance and most of all, reducing the towering level of government debt. This is important, given the less favourable external conditions than in previous years, in particular higher US interest rates (see also above).