Fear and uncertainty began to weigh more heavily on the global economy during the second quarter and although growth in 2019 seemed set to slow after a growth spurt in late 2017 and 2018, fear exacerbated the loss of momentum in the first half of this year.

The culprit behind these fears remains geopolitical risk, notably global trade. Global trade, already falling amid the backlash against globalization, is faltering under the weight of trade tensions, particularly tensions between the U.S. and China. This manifested itself most prominently in the manufacturing sector of the global economy, which clearly experienced slowing in recent quarters. Increasingly this slowdown looks as if it is spreading into the services sector.

Most major economies should continue to expand, boosted by strong consumer confidence, tight labor markets in several key countries, and relatively loose monetary policy.

Nonetheless, even with economic growth expected to slow a bit more, the global economy should still manage to achieve a growth rate near 2.6 percent (compared to 2.9 percent in 2018). Although growth could fall below that level, which would represent the worst performance during the current expansion, a more dramatic loss of momentum appears unlikely. Most major economies should continue to expand, boosted by strong consumer confidence, tight labor markets in several key countries, and relatively loose monetary policy. The risk of a global recession remains nebulous for the balance of the year, even if growth continues to falter.

Global trade still a key risk

As noted above, global trade remains a focus of concern. The key U.S. – China relationship continues to vacillate between periods of hot and cold. After the U.S. threatened greater escalation in the second quarter, the two sides agreed to temporarily halt further trade measures and resume trade negotiations. Global markets took that as an optimistic sign.

But other trade tensions continue to simmer. Trade between the U. S. and India has turned more confrontational and the U.S. administration has delayed, but not eliminated, tensions between the U.S. and Europe. All of this contributed to continued declines in global trade volume. Global trade tends to lead the global economy, contributing to a darkening economic outlook.

Yield curves around the world continued to flatten, with several key economies (including the U.S.) facing inverted yield curves, which typically means a loss of faith in the near-term economic outlook.

Fear reflected in global yields and monetary policy

The fear reverberating through the economy is reflected in global yields. Already low by historical standards, yields around the world continued to decline in the first half of 2019. Roughly $13 trillion of government debt trades at negative yields, a record high. Yield curves around the world continued to flatten, with several key economies (including the U.S.) facing inverted yield curves, which typically means a loss of faith in the near-term economic outlook. Central banks around the world have either maintained or shifted to dovish stances in recent periods.

The U.S. Federal Reserve Banks (the Fed) was planning on raising rates further in 2019, but rate cuts appear more likely than increases at this juncture. And the European Central Bank, which appeared to at least prepare for the prospect of tightening, now sees rates unchanged through at least the middle of 2020 and could cut rates if data further weakens. Other major central banks are watching the data as well, looking for greater clarity before making decisions. The relative changes in interest rates will complicate currency exchange rates and global trade, depending upon how central banks act - as quickly as July.

Major economies already slowing

The current economic expansion recently became the longest in history, surpassing the dot-come boom of the 1990s.

In the U.S., the world’s largest economy, the current economic expansion recently became the longest in history, surpassing the dot-come boom of the 1990s. Growth is slowing as fiscal stimulus is fading, but fear of a recession in 2019 looks overdone. Trade policy is creating a noteworthy headwind, striking some fear into consumers and businesses alike. Yet, actual fallout from trade policy remains limited.

Underlying momentum still looks stout, particularly in the labor market. Despite some cooling, the unemployment rate still hovers near a half-century low as do unemployment claims. Meanwhile, although job growth is slowing, it remains at healthy levels. This puts the Fed in a tough position. While it would like to get ahead of any deterioration that could lead to a recession, the economy is growing at a rate greater than the long-run potential growth rate with robust consumer spending and no sign of deterioration in the labor market. The Fed’s decision on interest rates at its next meeting will hold far-reaching implications for other central banks and the global economy.

China
In China, the world’s second-largest economy, growth looks set to stabilize in the balance of the year. The long-term slowing trend in China’s economy persists, pushing growth towards its lowest level since 1990. Sensing that forces are increasingly weighing on growth, the federal government remains prepared to implement policies that should prop up the economy. Injections of liquidity are cooling, but firm government spending remain in place. Trade tensions with the U.S. remain the central risk factor this year. A healthy consumer should offset any loss of momentum from investment, but if the trade situations turns negative again, the economy could come under further pressure, weakening growth and darkening the outlook.

Japan
Japan appears headed for further slowing in 2019. Sentiment among businesses continues to look negative, particularly among manufacturers as they watch on the sidelines of the U.S.-China trade conflict. In recent periods exports and inflation looked weak, prompting questions about potential monetary policy measures. The Bank of Japan (BOJ) recently decided to leave rates unchanged, but if the situation worsens, it stands ready to intervene. If the yen appreciates as other central banks around the world lower rates, making exports relatively more expensive, then the BOJ could also lower rates. But it would do so reluctantly since the short-term policy rate is already negative. The federal government could also implement fiscal policy measures if an appreciating yen leads to further slowing in export and economic growth.

India flag
Even in India, where growth has performed the best among the world’s largest economies, a slowdown is occurring. The federal government remains committed to keeping its budget deficit on a downward trajectory while encouraging infrastructure spending and private investment. That could prove pivotal to growth given the recent weakness in investment activity which reduced the outlook for 2019. With inflation bottoming, the Reserve Bank of India (RBI) seems likely to cut rates later this year to help brunt the slowing in growth, particularly if trade tensions worsen.

In Europe, major Eurozone economies such as Germany and France continued to look weak. Economic growth in both countries is heading down toward 1 percent. Of note, industrial production in Germany still looks weak with disappointing data surrounding recent orders, likely impacted by the ongoing declines in global trade volumes. In France, internal pressures on the economy are easing, but external risks, namely from trade, loom over the outlook. The U.S. decision to delay the imposition of tariffs on the European car industry for six months looks like only a temporary reprieve and still impacts sentiment. The Eurozone services sector, somewhat insulated from trade issues, looks healthier and helps to prop up the overall economy amidst ongoing external risks.

In the U.K., the government delayed Brexit once again and a leadership change further complicates the economic outlook. With the deadline now pushed to October, the economy faces ongoing headwinds from the uncertainty surrounding Brexit. The next prime minister could end fiscal austerity and implement stimulus if headwinds to growth intensify. For now, growth in 2019 looks like that of its larger continental counterparts – weak but positive.

In the rest of the Americas, the Canadian economy is holding up relatively well despite some recent slowing in job growth. Economic growth looks like it is rebounding after a soft patch in late 2018 and early 2019. In Brazil the prospect for a recession in the first half of 2019 increased in recent periods after a contraction during the first quarter. In Mexico, after the U.S. administration backed away from its serious threat to impose tariffs on exports, the economy looks headed for a rebound in the middle of 2019 after an unexpected pullback during the first quarter.

Implications for the U.S. economy and CRE

The U.S. economy lies at the heart of some of the key issues surrounding the global economy. If trade tensions abate, both the U.S. economy and the global economy should perform relatively well this year. If tensions worsen and the mood sours, the Fed will attempt to offset this by lowering rates, which seems almost inevitable at this point, at least to some extent. Easing tensions could help exports at a time when domestic demand is fading along with fiscal stimulus.

For commercial real estate (CRE), the fallout from trade tensions remains limited, impacting sentiment more than hard data. But if things escalate further collateral damage will increase. For fundamentals, the industrial sector remains the most at risk. After construction increased in the sector for the last few years, any demand pullback would be unwelcome.

On the capital markets side, we reiterate our concern about a potential bubble if the Fed cuts rates, especially if the fallout from trade tensions remains minor. Either way, the major risks facing the U.S. economy and CRE market remain domestic, not foreign, so U.S. policymakers’ decisions will matter the most.

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