IMF Lowers Global Growth Forecasts for 2018 and 2019

The International Monetary Fund cut its global economic growth forecasts for 2018 and 2019 to 3.7 percent from 3.9 percent, saying that trade policy tensions and the imposition of import tariffs were taking a toll on commerce while emerging markets struggle with tighter financial conditions and capital outflows.

The IMF Global Economic Growth Forecasts report reads in Chapter 1 on Global Prospects and Policies: “Beyond the next couple of years, as output gaps close and monetary policy settings begin to normalize, growth in most advanced economies is expected to decline to potential rates well below the averages reached before the global financial crisis of a decade ago. Medium-term prospects remain generally strong in emerging Asia but subpar in some emerging market and developing economies … The balance of risks to the global growth forecast has shifted to the downside in a context of elevated policy uncertainty … While financial market conditions remain accommodative in advanced economies, they could tighten rapidly if trade tensions and policy uncertainty intensify, or unexpectedly high inflation in the United States triggers a stronger-than-anticipated monetary policy response. Tighter financial conditions in advanced economies could cause disruptive portfolio adjustments, sharp exchange rate movements, and further reductions in capital inflows to emerging markets, particularly those with greater vulnerabilities.”

In an addendum to the just released IMF forecasts, Maurice Obstfeld who is the Economic Counsellor and Director of Research at the IMF writes: “Growth in the United States, buoyed by a procyclical fiscal package, continues at a robust pace and is driving US interest rates higher. But US growth will decline once parts of its fiscal stimulus go into reverse. Notwithstanding the present demand momentum, we have downgraded our 2019 US growth forecast owing to the recently enacted tariffs on a wide range of imports from China and China’s retaliation.”

I think, investors could do well by putting Mr. Obstfeld’s opinion on U.S. growth on their radar screens as well what is written in Chapter 1 of the report under “Scenario Box 1. Global Trade Tensions” on pages 33 to 35, which is a simulation exercise that was done to show trade war risks to the global economy. The IMF modeled the effect of an all-out U.S.-China trade war, coupled with threatened global U.S. automotive tariffs and retaliation from trading partners. The model also includes the effects of a reduction in business confidence that reduces investment and leads to a tightening of financial conditions.

The IMF found that global GDP output under this scenario would fall by more than 0.8 percent in 2020 and remain roughly 0.4 percent lower in the long-term compared to levels without these effects. The effects on the U.S. and China would be particularly severe, with 2019 GDP losses of more than 0.9 percent in the U.S. and 1.6 percent in China in 2019.

The exercise assumes that the U.S. imposes tariffs on the remaining $267 billion worth of Chinese goods imported not already under punitive tariffs and China retaliates in kind. It also assumes that a 25 percent tariff is imposed on imported cars and auto parts imports.

U.S. Treasury Yields Hit 7-Year High

U.S. Treasury yields hits a new 7-year high, which doesn’t bode well for equities. Both the S&P 500 futures and the Stoxx Europe 600 Index look poised for a 4th day of declines.

So, a gloomy mood continues to permeate markets, and it looks like the latest report from the IMF will do little to spur investor confidence.

The fund has reduced its outlook for global growth for the first time since 2016, in part because of growing trade tensions between the world’s two largest economies.

China has taken steps to aid lending this week, a move that inevitably puts downward pressure on the Chinese yuan (CNY), with weakness of the currency threatening to further aggravate the trade tensions in a vicious circle that could prompt more Chinese easing.

If the trade confrontation continues, chances grow that the Chinese currency (CNY) will go lower and that will create a whole host of problems for the global economy and certainly for the emerging economies.

U.S. Treasury Secretary Steven Mnuchin has faced pressure from the White House to formally designate China a currency manipulator in the Treasury Department’s semiannual Report to Congress that is due next week.

The yuan has lost 9 percent against the dollar in the last six months, which has raised speculation that China has been deliberately weakening its currency.

Etienne "Hans" Parisis is a bank economist who has advised investors on financial markets and international investments.