GDP growth in the U.S. shows that the current cycle still has legs, but signals from bond markets point to a more bumpy road ahead. While Europe is still waiting for a Brexit decision, authorities in China are actively stimulating the economy.
1. Bond markets are sending out negative signals about the otherwise still rather solid U.S. economy.
The U.S. is the fastest-growing major developed economy, a role that becomes particularly important in a context of slower economic growth globally. For this reason, any sign of weakness in the U.S. economy is viewed with apprehension by investors around the world. GDP growth in the U.S. in Q4 of last year has been revised downwards to 2.2%, a tad lower than expectations of 2.3% growth and significantly weaker than the 3.4% achieved in Q3. However, what has unsettled investors the most is the inversion of the yield curve, a phenomenon that in the past has often preceded recessions. On page 2 we discuss what’s behind this evolution and why this leading indicator for recessions may turn out to be misleading.
2. A buoyant services sector in Europe cannot quite make up for the slowdown in manufacturing and Brexit gridlock.
Meanwhile, economic developments in Europe offer little to cheer investors up. While Brexit remains mired in a gridlock, with every main outcome still possible, manufacturing activity in the Eurozone is weakening further, especially in Germany. As a result, the 10-year Bund yield has fallen below zero. On the other hand, the service sector is holding up much better, which goes to show how the main drivers of the continent’s economic fortunes, weak external demand and rather more solid domestic consumption are pulling economic data in opposite directions. We analyze what’s going on in more detail on page 3, before showing how this week’s votes in the UK parliament have influenced our view on Brexit.
3. Weaker trade and a contraction in manufacturing are hurting industrial profits in China, but tax cuts are likely to help.
The Chinese economy is grappling with a bout of weak economic data of its own. The National Bureau of Statistics has published disappointing data for industrial profits in the first two months of this year. While some of this retrenchment is no doubt distorted by the timing of this year’s Chinese New Year holidays, there are more fundamental factors at work, too. Similarly to what we are witnessing in Europe, corporate profits in the automotive industry are particularly challenged, while consumer goods keep benefiting from rising sales. Inflation is softening as well, which seems to suggest a case of eroding corporate pricing power. The government’s stimulus measures, already less generous than in previous downturns, are subject to a certain time lag before having a measurable impact on the economy. We expect to see a positive effect from Q3 onwards. However, the cut in value-added tax should have a more immediate benefit. We discuss the details and reach our conclusions on page 5.
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