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Will The Current Slowdown Shift To A Downturn?

This article is more than 4 years old.

Right now, a number of forward-looking measures are pointing to a global slowdown, driven mainly by trade uncertainty. Of course, gloomy outlooks don’t always result in setbacks but decent historical trends can end abruptly if sentiment shifts.

For that reason, it is essential to differentiate between hard and soft economic data. While both inform markets, hard data confirms current conditions while soft data captures expectations. But both feed on one another. Nervous outlooks can quickly become self-fulfilling, and if trade tension doesn’t de-escalate by early next year, this slowdown could quickly morph to a downturn. 

Global growth has slowed since last May, when U.S. protectionism began to disrupt key trading relationships that caused the manufacturing sector of major global economies to contract. While the U.S. was initially immune, that changed in August as the manufacturing outlook started to slip. 

The immediate risk is that manufacturing weakness spreads to the much larger service sector, which could threaten global growth. Evidence is already percolating. September’s non-manufacturing PMI’s weakened across the U.S., Japan and the eurozone. Germany in particular saw services cool. When combined with a slate of already sluggish data, Germany appears headed to recession. 

Other forward-looking measures also point to a global slowdown. The OECD’s composite leading indicators, which aggregates 38 countries, is hitting a ten year low suggesting a deteriorating outlook.   

U.S. Forward Views Are Cautious  

Historically, U.S. manufacturing and non-manufacturing sectors have a high correlation. Manufacturing tends to dip first in downturns, and as the downturn intensifies, it spills over to non-manufacturing or services. 

The recessions of 2001 and 2008-09 saw rapid manufacturing contractions that triggered weakness in services. Since the crises, we have seen two manufacturing contractions - 2012-13 and 2014-16 - but neither triggered a recession. It’s worth noting that these manufacturing disruptions were mostly driven by export and industrial weakness. That allowed services, which tend to be more domestically focused, to avoid a serious setback. 

In 2012-13, the eurozone weakened as Greece defaulted on its debt and threatened to exit the Union. Growth in the region faltered and spilled over with U.S. manufacturing also taking a hit. Meanwhile U.S. domestic demand stayed vibrant and the services economy motored on. 

During 2014-15, oil prices dropped as global inventories swelled on the surge in U.S. shale oil production. Saudi Arabia kept over-producing in the hopes that weak prices would drive marginal shale producers from the market. However, many held on and after eighteen months Saudi conceded and started rationing supply to help stabilize prices. 

During that period, a number of significant energy projects were abandoned. Funding dried up and new equipment orders were cancelled. The global energy sector found itself in recession. And while industrial manufacturing was weak, consumers and the service economy benefited as oil prices dipped. 

However, today’s trade disruption is impacting sentiment in both the manufacturing and non-manufacturing sectors. This uncertainty is forcing companies to pull back and delay strategic moves. Meanwhile, tariffs are starting to hit the consumer and with more on the way, the service sector is concerned that demand could soften.    

What’s Next?

With forward views showing strain, U.S. hard data is still holding up - although with mixed results. The unemployment rate is at a 50-year low and retail sales are still strong. Housing data has been sluggish but recent rate cuts are helping. Wage growth had been recovering but the most recent print shows it sliding back below 3%. 

Corporate profits are near record highs but have stalled as companies grapple with supply chain disruptions and tariffs. Upcoming profit guidance has a record number of S&P 500 technology companies expecting a third quarter earnings dip. None of this is a surprise as technology is the most globally exposed sector. It is also at the epicenter of intellectual property disputes with China.  

The growth path from here depends a lot on the consumer. While consumer confidence is still high, it is losing steam. Year-over-year changes have turned negative. The biggest drag on sentiment has been the trade impasse with China. 

While trade negotiations restart this week, expectations for a grand bargain remain low. But any effort to de-escalate either through an improved tone or freezing further tariff increases could ignite some optimism. 

President Trump is entering an election year, while China’s President Xi Jinping has a job for life. Neither wants to be blamed for triggering a recession. If Trump slips in the polls China may decide to wait until after the presidential election to resolve trade. But a Democratic leader may not be any more sympathetic. 

Absent some trade progress in the next several months, today’s gloomy expectations could start to filter through to the hard data. At that point, a slowdown could easily shift to a downturn as business and consumers pull back. The U.S. economy doesn’t have a lot of buffers, therefore the next steps on trade need to be constructive.         

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