Shifting macro risks

A slowing US economy is attracting significant attention; but China poses a more significant risk to the global economy

The big economic story of the past two months has related to concerns about heightened risk of US recession.  US markets sold off heavily on economic concerns in August; and after recovering their losses, have dropped again over the past week: soft manufacturing PMI data was a catalyst, along with weakening labour market data.  The US economy is clearly slowing, and the Fed will begin to cut policy rates at its September meeting. 

However, my assessment is that US recession risk is overplayed.  The labour market data are not terrible; and other indicators, notably consumer spending, are in decent shape.  Households and firms will benefit from lower interest rates; fiscal policy will remain expansionary; capex will become an increasingly important growth driver (the ‘great reindustrialisation’); and US labour productivity data are robust. 

The political risk profile in the US has also reduced over the past several weeks, as the likelihood of a Trump victory has reduced: VP Harris is ahead in several (not all) nationwide polls, and more significantly has made gains in key states. The race is closer than in July.  Tuesday’s election debate will be another key moment.

Unlike the experience of his first term, a victory for Mr Trump would likely weigh on the US economic outlook. Mr Trump’s combination of sweeping tariffs, constrained immigration, threats to Fed independence, and general unpredictability create economic risks that do not exist to the same extent under a prospective Harris Administration (particularly when constrained by a divided Congress, as is likely). 

Across the Atlantic, Europe’s economy continues to grind sideways (eurozone GDP growth of 0.6% in the year to Q2), dragged down by large economies (notably France and Germany).  Tight macro policy, higher energy prices, competitive pressures, and the absence of structural reform are weighing on the European economy.  Changes to macro policy and structural reform are needed: watch for Mr Draghi’s report on European competitiveness, to be released on Monday.    

There are also elevated levels of political risk in countries like France and Germany (note the recent regional elections in Germany, and the challenges associated with appointing a new PM in France), which are not positive for the economic outlook.  Europe is not likely to be a significant contributor to global growth. Although encouragingly, several small trade-exposed European economies are strengthening.

The most significant change in the global economic outlook over the past few months is China’s weakening growth outlook.  China is on a structurally declining growth profile (demographics, weakening productivity growth, geopolitical rivalry, and so on) reinforced by the headwinds of the real estate sector.  Growth to Q2 was weaker than expected (at 4.7%), and my assessment is that growth will continue to undershoot.  Downside risks to China’s economic outlook have accumulated this year, increasing the likelihood of a sharp slowdown in growth. [see my recent client note: ‘China risks building’, August 2024]

A deleveraging process is biting on the domestic economy, there are emerging constraints on China’s export-oriented industrial policy, and capital inflows into China have been negative.  Market pricing of commodities, Chinese equities, and Chinese bonds all signal a markedly weaker outlook.  These China-related risks will become more evident over the next few months. 

This growth trajectory will create a series of global economic and geopolitical tensions, and not just for firms/economies directly exposed to China.  A sharp slowing of the Chinese economy at the same time as the US economy is (gradually) weakening and the rest of the G7 is moving sideways would lead to a loss of global economic momentum.  Much rests on the strength of the US growth engine.

My in-depth client notes over the past month have provided insights into China’s weakening economic outlook as well as near-term global trade flows (supply chains, geopolitics, and more).  And my client briefings have focused on the implications of the US elections, European political developments, global economic fragmentation, and the macro outlook. 

Get in touch (david.skilling@landfallstrategy.com) if you would like to discuss a trial to access these briefings and research.

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