The policy response to the 2008 Global Financial Crisis set in motion the geopolitical trends that would eventually see the pivot from leaders such as Obama, Gordon Brown and Angela Merkel to the populism of Trump and Brexit.
Quantitative easing may have restored economic and market strength, but this came at the expense of creating greater inequality within countries thus sparking the trend towards rising populism and introducing major risks and uncertainty to the global economic environment.
These risks are perhaps most evident when examining the political and economic trajectory of the United States and Europe. Trump has become the poster boy for the movement from globalism to nationalism that has been building in Europe, with populist, anti-European Union political parties gaining power in Hungary, Austria, Italy and more recently Sweden.
In a series of events with eerie similarity to the protectionism seen in the lead-up to the Second World War, Italy’s new leaders went so far as to suggest conducting a national census of the Roma population to identify any non-Italians, while US President Trump’s hard-line immigration policies saw US border patrol agents separating children from their families. Likewise, German Chancellor and EU stalwart Angela Merkel has seen her power dwindling as a result of her unpopular, but more sympathetic, stance on the plight of migrants.
As a consequence of Trump’s “America first” approach and controversial trade tariffs, strained relations between the US and other countries even led commentators to term the annual G7 summit in June the “G6 plus one”. Significantly, historical alliances are being upended as Trump provocatively suggested that Russia be invited to re-join the summit, embarked on a war of words with the Canadian Prime Minister and conducted a ground-breaking meeting with North Korean leader Kim Jong Un.
Adding in talks of trade wars, this volatility in the geopolitical environment will likely act as a headwind against the global growth momentum that we’ve seen in recent years, already sparking a sell-off of emerging market assets.
America is all about the T words – Trump, Tariffs and Trade
Last year saw synchronised economic growth with countries benefitting globally, where this year has seen global economic growth decoupling again with the US emerging as the winner.
US unemployment is currently at a 48-year low, and for the first time since the country started measuring the data, there are now more vacancies in the economy than unemployed workers. And heightened demand means that the cost of employment is also rising at 4% per annum – double the current rate of inflation at 2%.
Workers are thus benefitting from real wage increases, implying that inflation may continue to rise more rapidly than anticipated, possibly triggering higher-than-expected interest rate hikes. And as this happens and debt becomes more expensive, drawing liquidity out of the system, the cracks are increasingly starting to show, as seen in the cases of Turkey and Argentina.
Having said that, the US economy appears to be firing on all cylinders, which means that the fiscal stimulus Trump recently delivered in the form of tax relief for corporates and individuals was economically unnecessary. But given the upcoming mid-term elections, this stimulus and Trump’s stand-off with other nations on trade tariffs was likely more about generating propaganda and garnering popularity among voters than implementing strategic economic policy.
However, Trump is playing a fine balancing act, as increasing trade tariffs could inflate the price of goods and impact consumers’ pockets, losing him voter goodwill. On that basis, a full-scale trade war is unlikely to happen, as most countries will come to some sort of agreement with the US first.
Thus, despite the geopolitical tensions at play, Citadel’s global economic recession monitor indicates that the likelihood for a global recession in the next 12 months remains below 25%, as US momentum should continue to support global economic activity.
That said, the fiscal stimulus granted by Trump will likely see the American economy overheat, entering second half of 2019 with much higher inflation and interest rates, and a widening budget deficit on the back of tax cuts. The US will then likely reach its tipping point around late 2019, where economic growth may start to disappoint, sparking a recession.
Clouds building over Europe
Europe’s biggest challenges since the creation of the European Union have been political rather than economic, reflected this year in heightened populist pressure brought to bear by Italy, and the backlash against Angela Merkel and her unpopular immigration policies.
Arguably the anchor of the EU, if Merkel is voted out, the union will likely find it much more challenging to stay together. As one of the greatest beneficiaries of EU policies, Germany has played a key role in maintaining stability in the region, demonstrated by the country’s willingness to pay the bill to keep Greece in the EU during the euro crisis.
However, Italy is of far greater concern: not only is the country much larger, but Italy also represents one of Europe’s larger bond markets, and a number of non-Italian banks hold Italian eurobonds. If Italy were to exit the EU or default on its bonds, the consequences would certainly spill over into the global economy.
Adding to these tensions, European retail sales, industrial production and manufacturing data disappointed to the downside in the first half of this year, reflecting slightly subdued economic activity.
However, despite the political headwinds, the improvement in European economies since 2013 has been quite significant. Unemployment remains high in southern regions, but the numbers have improved over the past five years, while consumer confidence has rebounded to levels not seen since 2000, supporting spending power.
On this basis, the European Central Bank (ECB) announced that it will be reducing quantitative easing towards the end of this year, with the first interest rate hike expected towards the end of 2019.
China on the rise
As the US retreats further into isolation, Trump is also paving the way for China to adopt the role of a much bigger global superpower, as President Xi Jinping is seizing the opportunity to position the Chinese economy and benefit from improved foreign trade and relations.
Xi has reaffirmed his commitment to opening China’s financial markets and adopting a more open, flexible financial system, pushing through positive economic reforms such as allowing foreign banks to operate within the Chinese economy.
Like the US, China is also reviewing its income tax rates for the first time in seven years, offering greater tax relief to consumers. Unlike the US, however, China can afford to make these tax cuts.
China’s tax revenue largely comes from corporates and sales, and tax relief will strategically boost consumer spending, lessening China’s reliance on industrial infrastructure development to drive economic growth over the next five years.
Retail sales and industrial production have continued to grow 9% and 6% year-on-year respectively, while the government has continued to reduce spending on infrastructure development, slowing economic growth rates to a much more sustainable target of around 6.5%.
However, reduced infrastructure development in China bodes ill for South Africa and other emerging markets, placing additional pressure on commodity prices and currencies. China slowing further this year will add more pressure to the current emerging market turmoil.
The worsening inequality and resultant US isolationist tendencies as well as populist trends in the UK and Europe have seen a globe at odds with its past. Recent events such as the emerging market sell-off do point to tough times ahead.
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