UNIQA Capital Markets Weekly

Quarterly Macroeconomic Outlook: Fragile growth

• Eurozone: Stabilization at a moderate pace
• Central and Eastern Europe: Gearing down
• Central banks: Pause

The global outlook is fragile. In 2019 the global economy expanded at modest 2.9 % (OECD), which is the lowest growth rate since the financial crisis (2008-09). Despite recent de-escalation in the US-China trade conflict (phase-one deal), global trade keeps stagnating. The downward trend in business confidence has come to a halt and stabilized at low levels indicating a moderate expansion.

The manufacturing sector remains the weak link (Figure 1 - see pdf). Leading business cycle indicators, e.g. purchasing manager indicators (PMIs) and the US ISM index, indicate a continued weakness in manufacturing. Among major economies, Germany (43.7) shows the lowest momentum, followed by the UK (47.5), Japan (48.4), Euro Area (46.3), China (50.2) and the United States (47.2). A dichotomy exists between industry and services. Confidence in the service sector indicates expansionary momentum and PMIs tend to be more homogenous across countries.

The US expansion has become the longest in history, entering its second decade (post 05/2009). In recent quarters, the economy has become increasingly dependent on private as well as government consumption, as investment and exports declined. Nevertheless, fears of an eminent recession cooled. The inversion of the US yield curve reversed and business sentiment indicators stabilized. In 2020 economic growth is expected to moderate slightly, yet remain solid at close to 2 %. Moderate growth is set to continue as being supported by a healthy labor market. The unemployment rate is close to a half-century low (3.5 %), the pace of job gains remains solid (~200 thousand per month) and average hourly earnings expand steadily (3.2 %, y/y). Continued weakness in manufacturing, though, poses a downside risk.

The economic slowdown also encompasses emerging markets (Figure 2 - see pdf). In China GDP growth is expected to gradually slow to 5.5 % by 2021, being exposed to volatility in global trade. The Indian economy moderated in 2019, accommodative monetary and fiscal policy, though, should support growth. In Latin America, Brazil is recovering gradually and Argentina will stay in recession for the second consecutive year.


Euro Area: Stabilization at a moderate pace

• Business and sentiment indicators have stabilized at low levels, however, a turning point has not yet been fully confirmed by the data. Yet a recession was avoided and the Euro Area economy is set for a continued moderate expansion.

Recently, the Euro Area has avoided a further deterioration of the economic cycle. Financial investors’ sentiment improved towards year-end after data surprised positively – a recession was avoided in Germany – and chances for a January Brexit were rising after Boris Johnson’s election victory in December. However, a non-negotiated outcome remains on the table. The outlook is less skewed to the downside than earlier last year.

In Q3, real GDP expanded moderately by 0.2 % (q/q) after 0.3 % on average during H1 2019 (Figure 3 - see pdf). Growth remained predominately driven by domestic demand, while net international trade was a drag. Our nowcasting model indicates a sustained growth trajectory (0.3 % GDP growth) by year-end 2019. We expect the economic expansion to continue at a comparable pace in 2020.

Households consumption remains supported by solid labor market conditions. Compensation has been rising (2.1 % in Q3) partly due to higher negotiated wages (2.6 %), however, not enough to unleash higher inflation. The Eurozone unemployment rate has almost reached its pre-crisis low (7.5 % in November). However, the expansion of total employment has slowed last year (0.9 % y/y in Q3 after 1.5 % in 2018) exemplifying the slowing cycle.

Business sentiment has shown tentative signs of stabilization after a steady slowdown since 2017. Yet, fixed investment contributed solidly to GDP growth last year. Firms increasingly quote insufficient demand as a rising constraint (less so labor, equipment or financing conditions). The industry fell into contraction and has not yet shown signs of a recovery (-2.3 % y/y in October). Germans industry was protracted by year-end (production and new orders -2.6 % and -6.5 % y/y) likely linked to weak external demand.


CEE: Gearing down

• The economic expansion in Central and Eastern Europe continues (see Table 1 Summary). Growth, however, has become more fragmented across countries and sectors. Negative spillovers from a weak external environment have not only affected export demand but further led to a slowdown of the industry.

The economies of Central Europe (CE) continue to expand, yet the resilience to a weakening Euro Area economy has deteriorated in some countries. While Hungary (5 % GDP growth in Q3) and Poland (3.9 %) keep booming, growth has slowed in the Czech Republic (2.5 %) and Slovakia (1.3 %). Tight labor markets continue to support domestic demand. Substantial declines in unemployment rates are not to be expected as employment moderated. In spite of rising inflation, driven by food and services prices, CE central banks signal to hold interest rates constant over the medium-term as downside risks prevail.

In Romania the newly formed government, led by the National Liberal Party, faces the challenge to resolve a twin deficit (fiscal & current account) within a slowing economic outlook being characterized by growing macroeconomic imbalances.
Some growth upside is linked to the realization of national infrastructure projects in Russia in 2020/21, while otherwise the economy has a low medium-term growth potential. Ukraine maintains a recovery. Inflation has been declining quickly in recent months and paved way for monetary policy loosening. Central banks in both Ukraine and Russia have embarked on interest rate cutting cycles and are expected to maintain an accommodative stance in 2020.

Both Croatia and Serbia had rather strong growth in 2019. Weak external trade weighs on the economy of Bosnia & Herzegovina. Montenegro’s development has been driven by infrastructure investment for some time, while tentative signs of a slowdown are emerging. In Bulgaria strong household consumption has prevented a more pronounced growth slowdown. Growth remained solid in North Macedonia (> 3 %), being driven by well-balanced domestic demand. Albania’s economy is expected to keep expanding solidly.


Central banks: Pause

• Leading central banks have paused adjustments to monetary policy. Neither the ECB nor the Fed signal to lower interest rates, assuming that the economic outlook will not deteriorate any further.

Since the ECB has introduced its new stimulus package in September, no additional measures have been announced. Christine Lagarde, the new president, shares Draghi’s assessment that an ample degree of monetary accommodation is necessary. Yet, starting in 2020 a strategic review will be conducted which will re-examine the effectiveness and appropriateness of monetary policy instruments.

The ECB’s assessment of the Euro Area’s economic outlook is rather muted and risks remain tilted to the downside. In December ECB staff projected GDP growth and inflation at 1.1 % for 2020. Inflation pressure is weak and will converge to the ECB’s target only very slowly. Inflation is projected at 1.6 % at the end of the projection horizon (2022). Interest rates will not be increased before the inflation outlook has robustly converged to the target.

The Fed has completed its mid-cycle adjustment of three interest rate cuts and perceives the current stance of monetary policy as appropriate. For the year 2020, no changes in monetary policy have been signaled, projecting the federal funds rate to converge to its longer-run level around 2.5 % starting in 2021. The target range of the federal funds rate is currently set at 1.5 to 1.75 %.

As long as incoming data are consistent with the broader economic outlook (GDP growth, unemployment, inflation), no changes in monetary policy will be required. In December, the Fed projected the US economy to grow at 2 % in 2020, the unemployment rate to stay low (3.5 %) and inflation to remain close to the Fed’s target (1.9 %).

In Q4 2019, benchmark yields (Figure 5 - see pdf) have increased slightly in the US (10Y Treasury: +20 bp) and more substantially in the Euro Area (10Y German Bund: +40 bp). Euro Area sovereign spreads have remained broadly stable, except for Italy (+20 bp). Adjustments in risk sentiment (US-China trade deal) and revised expectations of rate paths (no further cuts by Fed and ECB) drove yields higher.


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