4 Black Swans And Why “Trumpflation” Is No Match For The End Of “Xiflation”

Well, SocGen is out with their Global Economic Outlook which, as you may or may not be aware, usually includes a picture of a bell curve with some swans on it.

I’m skeptical that anyone actually reads these things. As Reuters wrote earlier this year, “about 40,000 research reports are produced every week by the world’s top 15 global investment banks, of which less than 1 percent are actually read by investors.”

I’d be willing to bet that percentage is even lower for research that’s longer than 10 pages and these sprawling global outlook pieces are sometimes hundreds of pages long.

But everyone loves SocGen’s swans chart and in case you’re one of those people who generally thinks that the higher the swans-to-words ratio the better, here’s the updated visual:

Swans

The accompanying color on that is pretty straightforward. Here it is condensed and put into handy bullet points for ease of use:

  • Policy uncertainty has long been part of our risk factors linked to busy electoral agendas. For Europe, there is still a busy electoral agenda ahead. Our main concerns at this stage are about Italy and an ugly Brexit.
  • Across the Atlantic, the risk has shifted increasingly to finally seeing no US tax cuts delivered in FY18. We see a 30% risk that Trump will fail to deliver tax cuts, which would see the US economy slowing sharply as early as 2H18.
  • Fast track reform in Europe remains a hope, but we set a low probability on this at just 5%.
  • In China, the risk of a policy error is an ongoing issue. With the approach of this autumn’s Congress, we believe the near-term risk of a China hard landing is reduced. We have thus lowered the risk hereof to 15% from 20% previously, but expect to raise it again after October.
  • Low interest rates are the lynchpin of global markets, should confidence in the ability of central banks to respond to either upside or down side risks decline significantly, the risk is to see a sharp market repricing.

Again, nothing groundbreaking there. If you want a more complete discussion of the Italian issue see here. On China, you need only scroll through our recent coverage to find out everything you need to know with regard to what overtightening would entail both for domestic stability and for global growth more generally. On the last point (the bit about central banks’ collective capacity to respond, we would remind you of what Pimco said this week. To wit:

Policymakers are driving without a spare tire because of limited tools — caused by big balance sheets and low- or negative-interest rates — to deal with a recession [Additionally] policy measures may not be sufficient to counter the next downturn, whenever it materializes.

Far more interesting – in our view anyway – than the swans, is SocGen’s take on how “Trumflation” isn’t going to be enough to offset the wind down of “Xiflation” – especially not when the market has completely priced out Trump’s agenda, an eventuality we’ve discussed at length before.

Below, find excerpts from that section of the bank’s note…

Via SocGen

TRUMPFLATION INSUFFICIENT TO OFFSET FADING XIFLATION

China has enjoyed a strong recovery in nominal GDP since early 2016 and with that also a sharp recovery in nominal exports and imports. Reflation policies combined with the recovery in commodity prices explain the bulk of this move. Renewed concerns about China’s overreliance on credit, however, have triggered liquidity and regulatory tightening and we believe that China has already this spring entered a nominal growth slowdown. Although real growth is set to remain fairly stable over the coming quarters, the fact that China is shifting from reflation back in the direction of deflation is something we believe will matter both for global sentiment and trade dynamics.

The election of Donald Trump in the US boosted hopes of deregulation, tax reform and fiscal expansion. Hopes, however, have faded since the election and the latest developments with the investigation into the Trump campaign’s Russia ties mean that even our own below-consensus outlook now comes with greater downside risks. Prior to the election, our call had been for the US economy to enter a cyclical downturn in 2H18. Without the modest tax boost (around 0.3pp of GDP) that we factor in, this risk scenario could well materialise.

China’s ever-bumpy landing

Credit growth historically leads GDP growth by around three quarters in China and as illustrated in the chart below, if history is any guide, a slowdown in nominal GDP is already underway. As flagged by our China economists in a recent piece, the April data seemed to further confirm this picture. Import growth, in particular, slowed which is a trend we expect to continue, also given the sensitivity to commodity prices. More encouragingly, housing data – be it mortgages, sales, investment or construction – remained fairly resilient. Turning to the real side of the economy, we expect the coming quarters to hold fairly stable; heading into 2018, however, we look for softer growth.

SocGen1

There are several key factors behind our call; one of the notable elements being regulatory reforms. While reform is encouraging, it comes with a cost to growth (at least for the foreseeable future which will make it harder to opt for the all-too-well-known stop-go credit policy) but with a win for future financial stability. If the leadership confirms a growth target of below 6.5% at the Party Congress this autumn, that would be the clearest sign yet of a firm commitment to reform.

As outlined in the previous section, Chinese balance sheets are very fragile and orderly deleveraging will be a very lengthy process. Capital outflow pressure is structural and deeply rooted in the excessive debt load. While capital controls have tamed near-term risks, China remains vulnerable especially if faced with sharply rising global interest rates and sharp dollar appreciation. Protectionism is a further risk.

Fading hopes for Trumpflation

Hopes that President Trump would deliver on regulatory and tax reform with the extra boost of a fiscal stimulus have been fading over the past months and more so with the latest developments in Washington. Our forecast of 2.2% for 2018 remains slightly below the Bloomberg Consensus of 2.3% and that of Consensus Economics at 2.4%, but we expect these gaps soon to narrow. Moreover, our call for the US economy to slow in 2H19 remains a well out of consensus view. The Bloomberg consensus stands at 2.2% – a full 1pp above our 1.2%. Markets have faded the Trump rally, but are not factoring in a sharp US slowdown in 2019. The outlook for US policy is clearly critical to our forecast, all the more so at a moment in time when China is losing momentum (albeit very slowly in real terms).

SocGen2

The bottom line is that while we continue to expect some tax cuts, tax and regulatory reform seem increasingly unlikely. That somewhat depressingly increases our confidence that 2019 will see the end of the current expansion, with the knock-on effects that this will entail not just for Fed policy, but the global economy as a whole.

Should tax cuts fail to materialise, the US economy could well lose momentum as early as 2H18. Mechanically, cutting 1.0pp from the US outlook would knock around 0.25pp off global GDP growth in 2018. Note, that if China were to suffer growth 1pp below our forecast, that would also knock 0.15pp off global growth. Our baseline scenario is for China to slow by 0.5pp between 2017 and 2018. To offset that, based on this simple calculation, the US must expand by an additional 0.3pp in 2018.

 

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2 thoughts on “4 Black Swans And Why “Trumpflation” Is No Match For The End Of “Xiflation”

  1. Look at your global gdp growth bars for China and USA. How much of that growth is actually contrived? How far is this world from healthy organic growth? The remedy seems to be leadership. Is lack of leadership a gigantic black swan?

    • Not necessarily. The US has suffered abysmal, counterproductive top leadership (from both sides) for many years although US muddled through for other various reasons.

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