While a slowdown in US growth looks increasingly likely next year, the impact on the wider global economy should be limited, according to Capital Economics’ Vicky Redwood.
The US economy has grown at a faster rate than the rest of the world over the past year, fuelled by a package of tax cuts enacted by Republican president Donald Trump.
However, the one-off impact of the tax cuts is likely to have been exhausted by 2019 with growth set to fall in line with the rest of the world.
Real GDP growth (annual per cent change)
Source: International Monetary Fund
As Merian Global Investors chief executive Richard Buxton noted, a combination of the Federal Reserve's rate-hiking regime and increased trade tensions are likely to contribute to a slowdown in growth.
“It’s going to slow down from supercharged growth of near 4 per cent to 2.5 per cent next year,” he said. “As the Federal Reserve nudges rates up, the dollar – presumably – will soften a bit and out of this process the US will resynchronise relative to the rest of the world.”
Buxton added: “Between what’s gone on in the emerging markets, Europe and so on, the US has really caused dislocation in markets.”
Yet, as the US economy likely slows down during the coming year, the impact on the wider global economy should be limited, according to Capital Economics senior economic adviser Vicky Redwood.
“The US slowdown that we anticipate next year will weigh on global growth, but the impact will be relatively mild by past standards,” said the economist.
She explained: “Although there has been a reasonably close relationship between GDP growth rates in the US and the rest of the world in the past, this has often reflected common global shocks.
“It should therefore be of some comfort that the US slowdown that we expect will be largely home-grown, driven by domestic factors.”
Indeed, during previous slowdowns, US and other global economies have had greater alignment of business and interest rate cycles.
“For example, many countries experienced downturns in the 1980s and early 1990s because they had raised interest rates to quell inflation,” said Redwood.
“And while the sub-prime crisis in the US was the immediate trigger of the global financial crisis, it may not have taken place if interest rates in the rest of the world had not been so low.”
This time, however, the Fed has been alone in tightening policy while central banks from other advanced economies have shown more caution despite a decade of quantitative easing and ultra-low rates.
International forward interest rates
Source: Bank of England Inflation Report, November 2018
The only other major central bank to have lifted rates more recently is the Bank of England, although this followed a rate cut in the wake of the EU referendum in 2016.
The recent downturn in markets has been sparked somewhat by fears that the Fed could cut faster than anticipated in order to reach its ‘neutral rate’, although some strategists and economists now believe that the central bank could be forced to cut rates to reverse course to avoid recession.
“This means that interest rates in some areas will be rising at the same time as the Fed is cutting rates,” explained the economist.
While a US slowdown is not to be too feared, investors should not disregard the impact completely, warned Redwood, as slower growth would have a knock-on impact on countries with trade and financial links.
Another reason that a slowdown in US growth might not be as damaging for the global economy is due to the fact that it “is not as crucial for the world economy as it once was”.
“Since 2000, the share of the main developed countries’ exports sent to the US has fallen from 19 per cent to 12 per cent,” she said.
“Admittedly, the US remains the dominant force in financial markets. Corporate bond spreads in the US and elsewhere would probably rise, which could dent investment,” noted Redwood.
“But emerging markets are better placed than in recent years to withstand a pull-back in capital flows. And any falls in equity prices are unlikely to be big enough to have significant wealth effects.”
Additionally, most countries will also be able to use domestic policy to offset some of the impact of a US slowdown with a range of tools from interest rates to fiscal policy.
A sharper US downturn could have a more significant impact on the global economy although the severity would depend on why it was worse, said Redwood.
“Things would get more serious if the US economy slowed more sharply because of some sort of global shock,” she explained.
For example, the unwinding of quantitative easing could prompt a sharper rise in bond yields driving borrowing rates up.
Meanwhile a spike in inflation could force the Fed to make further hikes; if inflation were a global phenomenon then other central banks could follow suit and lead to a re-run of the multiple recessions seen in the 1980s and early 1990s.
A “much worse scenario”, according to Redwood, would be a US default on Fed debt or a new financial crisis driven by corporate debt.
“With banking systems appearing safer, a meltdown in the financial system, as was triggered by the US sub-prime crisis in 2007, would probably still be avoided,” she said.
“Nonetheless, a deep US recession would exacerbate the Italian situation, make it harder for the eurozone and Japan to raise inflation and leave policy arsenals in many areas even more dangerously depleted.”