Political worries, flatlining growth and an illiberal cycle

  • Over the summer, escalating political risks (U.S.-China rivalry, Brexit, Italy’s new government) exacerbated the pockets of recession visible in the first half of the year in trade, manufacturing and a dozen of economies. Looking ahead, a soft landing remains our baseline scenario (+2.4% in 2020, down from +2.5% in 2019 and +3.1% in 2018). In 2020, the U.S. should decelerate to +1.6%, the Eurozone to +1.0% and China to +6.1%. Global trade of goods and services will grow by +1.7%, the lowest rate since 2009. Consumers will be a source of resilience (low unemployment and high savings); domestic sectors, such as services and construction will help bridge a pivotal H1 2020, before easing monetary conditions and lower political risk help the manufacturing sector recover in H2 2020.
  • This time around, expect more volatile markets and fickle capital flows, as our fragmented world has entered an “Illiberal Cycle”. Low-growth-low-inflation may hide more direct pass-through from political risks to financial markets, and the need to manage negative externalities of very interventionist policy-makers. Though we expect pragmatism on the U.S.-China trade tensions as the U.S. economy decelerates, a last minute extension of Article 50 in the UK, and few(er) mistakes by neo-authoritarian leaders in emerging markets, fiscal and monetary policy – as well as tax, tech, and competition policies – will continue to be instrumentalized to offset trade uncertainty or win elections. However, these policies will exhibit diminishing returns, given increasing vulnerabilities of the private sector and capital markets. A more fragmented world also means volatile commodity prices (~70$/bbl for oil), currencies (3-5% depreciation on average) and capital flows for emerging markets.
  • To exit these limbos, there are two upside possibilities, and two downside risks. Potential positive developments include: an electoral bifurcation in the U.S. in 2020 and a moratorium on protectionism (40% v. 60% for more of the same), and a sizeable fiscal response from Europe, taking the baton from the U.S. (20%). These would call for rapid normalization by central banks to avoid exuberance. On the negative side: a credit event from a zombie corporate in the U.S., for instance (20%), a major policy and a full-fledged U.S.-China trade and currency war (10%) will trigger a recession.
  • What does this mean for markets? Along with rising volatility, the directionality of global markets will be hard to get. Historically, fixed income assets have been the outperformers in late cycle periods. A severe economic downturn would lead equity markets to a double digit downward correction. The superdovish central banks will keep bond yields at very low levels. We expect the 10 year Bund at -0.4% at end-2020 and the 10 year U.S. yield at 1.7%. The ongoing uncertainty would push gold prices to higher levels even though at the moment there is not enough confidence to take outright long positions. Higher volatility from the U.S.-China trade conflict will keep the dollar strong (1.10 at end-2019 and 1.12 at end-2020 for the EUR/USD). The renminbi should depreciate further to 7.23 for the CNY/USD in one year term).
  • What does this mean for companies? Our Global Insolvency Index is forecasted to increase by +8%, both in 2019 and 2020, with a still noticeable increase in Asia (+15% in 2019 and +16% in 2020), a rebound in Western Europe (+3%) and a trend reversal in North America (respectively +2% and +4%).

 

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Ludovic Subran
Allianz SE
Alexis Garatti
Euler Hermes
Ana Boata
Allianz Trade
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Economic Research Team