1. Research
To listen to a podcast version of this article click here

Green shoots or false down?

The past year and a half has seen an impressive slide in the global economy. Global GDP growth is expected to have ebbed to its lowest rate since the great recession this year, with some regions nearing recession and others increasingly fearing it. The primary factor is the strongly depressing effect on global trade and investment that has resulted from sharp increases in economic policy uncertainty associated with both trade policy conflicts and Brexit.

Tentative signs of an easing or even ending of the downtrend in global growth have emerged. Financial markets have gotten a lift from both an easing of trade tensions and some more constructive developments on the Brexit front, with equity values boosted, credit spreads narrowed, and yield curves steepened. PMIs and other leading indicators of business activity appear to be forming a trough. Our view for some time has been that global growth would bottom by the turn of this year and begin to pick up gradually over the year ahead, although with significant downside risks attached to this baseline scenario. 
Assuming the global economy is nearing a turning point, could we be too pessimistic in our perception that a current bottoming is fragile and our expectation of only a slow pickup in growth over the year ahead?
While some risks remain, there are reasons to be feeling a bit better. We began by reviewing recent more favourable developments in the key headwinds to global growth, namely trade tensions between the US and China (and others) and the prospects for a disruptive UK exit from the EU. We considered in particular empirical evidence of the extent to which key policy announcements have affected the level of policy uncertainty. We reviewed global evidence, namely the recent behavior of leading indicators of global economic activity, including global PMIs and various measures of global financial conditions. Our analysis pointed to a near-term bottoming of global growth that should prove sustainable as long as risks related to trade policy and Brexit are resolved positively.
Recent developments suggest the global economy may have dodged a bullet in late summer, when the Trump Administration announced significant new tariffs on China with a response in kind by China, and simultaneously, developments in the UK appeared to push the likelihood of a no-deal Brexit above 50/50.
The uncertainty created by these events weighed significantly on global trade and investment. The Fed staff’s trade policy uncertainty index jumped during August on these developments. The stock market dropped, the US manufacturing ISM fell below 50, and a key conventional US yield curve slope (2s-10s) inverted for the first time since before the great recession. This caused recession probability models to flash warning signals of elevated recession risk. Some major European countries were already in or near recession, and growth in China and the US was showing clear signs of slowing. But, the picture changed this fall when risks associated with both trade tensions and Brexit appear to have taken a turn for the better.
The Trump Administration appeared to shift course when it announced on October 11 a tentative Phase I of a larger trade deal with China. The announcement included an indefinite delay of the scheduled mid-October tariff increase. A finalized Phase I deal would also remove or delay through next year the tariffs scheduled to be imposed in mid-December on remaining imports from China (mostly consumer technology goods, including cell phones, laptops, and other consumer goods). In exchange, China is expected to commit to larger agricultural purchases, rein in technology transfer, bolster protection of intellectual property, and commit to greater transparency on foreign exchange reserves with a commitment not to manipulate the currency market.
There are risks on both sides of this assumption. It is possible that China will seek a rollback of existing tariffs to agree to such a deal. The US Administration has sent mixed signals on the likelihood that it would go along with this condition. Should this or events surrounding Hong Kong prove to be a major sticking point, the deal could fall through and trade policy uncertainty remain elevated, yielding a worse outcome than we expect. Should the US agree to a rollback, the outcome could prove more positive than we expect. In other very recent developments on the trade front, US Administration and Congressional officials (most notably Trade Secretary Ross and Senate Finance Committee Chairman Grassley) have indicated that prospective tariffs on imports of autos from Europe and elsewhere will be delayed or dropped, though no official announcement has been made.
Hopes for a positive Brexit outcome improved when new UK Prime Minister Boris Johnson renegotiated the Withdrawal Agreement with the EU by adopting a Northern Ireland-only backstop. Although the Government won a vote on the second reading of the Withdrawal Agreement Bill in Parliament, a procedural motion was subsequently lost, and to break the impasse a general election on 12 December was called.
However, two issues still create risk. First, even if Johnson’s deal is ratified in January, the UK could still crash out of the EU at the end of 2020 unless a new trade agreement is reached. The ‘deal’ only secures transition. This means another Brexit cliff edge will occur in June 2020 when a decision must be made on an extension of the transition period beyond December 2020. In our view, it would be next to impossible for the UK and EU27 to agree to even a simple free trade agreement in the next 12 months.
Secondly, the size of the Conservative majority will have important ramifications. The larger the Conservative majority, the less dependent Johnson will be on hard Brexit MPs and the more the door opens to a closer economic partnership with the EU than the one suggested in the current draft of the future relationship. Conversely, the smaller the Conservative majority, the greater the risk of a more distant economic relationship.
The full report is available to clients of Deutsche Bank Research.
For important disclosure information please see: https://research.db.com/Research/Disclosures/Disclaimer

© Copyright 2022. Deutsche Bank AG, Deutsche Bank Research, 60262 Frankfurt am Main, Germany. All rights reserved. When quoting please cite “Deutsche Bank Research”.

The above information does not constitute the provision of investment, legal or tax advice. Any views expressed reflect the current views of the author, which do not necessarily correspond to the opinions of Deutsche Bank AG or its affiliates. Opinions expressed may change without notice. Opinions expressed may differ from views set out in other documents, including research, published by Deutsche Bank. The above information is provided for informational purposes only and without any obligation, whether contractual or otherwise. No warranty or representation is made as to the correctness, completeness and accuracy of the information given or the assessments made. In Germany this information is approved and/or communicated by Deutsche Bank AG Frankfurt, licensed to carry on banking business and to provide financial services under the supervision of the European Central Bank (ECB) and the German Federal Financial Supervisory Authority (BaFin). In the United Kingdom this information is approved and/or communicated by Deutsche Bank AG, London Branch, a member of the London Stock Exchange, authorized by UK’s Prudential Regulation Authority (PRA) and subject to limited regulation by the UK’s Financial Conduct Authority (FCA) (under number 150018) and by the PRA. This information is distributed in Hong Kong by Deutsche Bank AG, Hong Kong Branch, in Korea by Deutsche Securities Korea Co. and in Singapore by Deutsche Bank AG, Singapore Branch. In Japan this information is approved and/or distributed by Deutsche Securities Inc. In Australia, retail clients should obtain a copy of a Product Disclosure Statement (PDS) relating to any financial product referred to in this report and consider the PDS before making any decision about whether to acquire the product.