Autumn outlook: Disruptive divergence
The global economy is caught in an asymmetric slowdown, with the US outperforming the rest of the world. The result is a double whammy of monetary tightening via higher interest rates and US Dollar appreciation. Ultimately, this disruptive divergence creates an unstable equilibrium: Either the US has to slow or China and the rest of the world need to accelerate. For now, we believe divergence is here to stay, as Dollar strength in itself reinforces this theme by hurting regions outside the US the most. Further down the road, the path of least resistance is slower US growth, as the headwinds to Chinese growth seem to have more staying power than the tailwinds of the US economy. Meanwhile, the big top in equities is getting closer. The almighty US Dollar is key: If the Greenback appreciates further form here, it should tighten monetary conditions enough to trigger a big top within the next six months. In light of rising macro risks, defensive sectors and regions should outperform within equities and safe havens increasingly be sought after.
Diverging outlooks: Stronger US growth comes at a cost
The macro narrative has changed from “synchronised recovery” in 2017 to asymmetric slowdown in 2018. We believe the global economy passed “peak growth” in H1 2018 as a result of a double whammy of monetary headwinds: Rising US short-term real rates (despite higher inflation) and a stronger US Dollar. These headwinds are slowly but surely gathering pace as inflation in the west is ticking up, confirming our view of a less favourable growth/inflation trade-off. In July, US core inflation hit the highest levels since the financial crisis.
A key driver behind the monetary tightening is a disruptive divergence between the major economies (see charts below). On the one hand, US growth is holding up well, enjoying the cyclical tail winds from Trump’s tax cuts. China is on the other end of the scale. Its economy is slowing as a result of reduced credit flows and the asymmetric pain protectionism imposes on the global economy. The US is the relative winner of the ongoing US – Sino trade conflict, as its economy is large and relatively closed. China, on the other hand, being one of the main winners of past decade’s globalisation, is bearing the brunt of the pain.