Global growth has not only plateaued in 2018, it has also become more uneven across regions this year. We’reseeing increasing economic divergence and differentiation between and within asset classes, both of which aretypical of an aging expansion.
Our latest Cyclical Outlook, “Growing,But Slowing,” highlights the macro trends and market developments that underpin our outlook for 2019:slower growth, but likely no recession.
A few of the “rudeawakenings” that we discussed in our longer-term Secular Outlook in May have alreadymanifested in the last several months, including the intensification of the China-U.S. trade dispute, the brewingconflict between the EU and the populist Italian government, the recent turmoil in emerging markets, and theperiods of volatility in global equities – all of which underscore our secular emphasis on caution andliquidity.
These recent political and market developments are relevant for the cyclical outlook because they have tightenedglobal financial conditions and increased political and economic uncertainties, which are all likely to dampcorporate and consumer “animal spirits” around the world.
Baseline outlook for 2019
Against this backdrop and with the fiscal stimulus in the U.S. starting to fade next year, our cyclical baselinesees this year’s economic divergence – with U.S. growth accelerating but the rest of the world slowing– giving way to a more synchronizeddeceleration of growth in 2019. In our forecasts, the big three – the U.S., the eurozone and China– should all see lower GDP growth in 2019 than this year: Growing, but slowing.
However, economic activity in the major economies, while slowing, is still likely to keep expanding at anabove-trend pace and thus absorb more of any remaining slack in labor markets over our cyclical horizon. Inresponse, we expect the major central banks to continue to remove accommodation gradually.
While we continue to believe that a recession over our secular three- to five-year horizon is quite likely, arecession next year is not our base case, and so we expect to remain in the late-cycle stage for some time. So far,none of the domestic imbalances that typically precede recessions have developed: over-consumption,over-investment, a housing bubble or excessive wage growth.
We view the risks around our “growing but slowing” baseline as broadly symmetric, with trade policybeing the main near-term swing factor for better or worse outcomes.
Other risks include the brewing conflict in Europe over the Italian budget and potential upside risks to businessinvestment in the U.S. in response to strong earnings growth, deregulation and rising capacity utilization.
Elsewhere, the outlookfor many emerging market economies remains challenging in an environment of slowing global trade growth,rising U.S. interest rates and domestic political uncertainties. And if the situation in emerging markets continuesto deteriorate, it would likely feed back into the U.S. eventually via excessive U.S. dollar strength and weakerglobal trade growth.
Flexibility and caution
While our baseline is for a global economy that is “growing but slowing,” there is the potential forhigher macro uncertainty and volatility. In our portfolio construction we think it makes sense to emphasize cautionand the range of risks outside the baseline. We want to maintain flexibility to respond to both positive andnegative shocks. If we need to give up some portfolio yield in exchange for this flexibility – for example,by holding more highly liquid short-term instruments – then that looks like a reasonable trade-off in thecurrent environment. We will look to generate income across a broad range of sources, without relying on corporatecredit overweights.
We cannot precisely predict the timing of the turn in the credit cycle, but we can try to ensure that we arewell-prepared for the event.
Read PIMCO’s latest Cyclical Outlook, “Growing,But Slowing,” for further insights into the 2019 outlook for the global economy alongwith takeaways for investors.
Joachim Fels is PIMCO’s globaleconomic advisor and a regular contributor to the PIMCOBlog.