Last week it was Morgan Stanley, today it is SocGen’s turn. 

Societe Generale’s latest Global Economic Outlook report titled “Storm Clouds Gathering” is gloomier than the last three editions. The French bank’s posits that while global growth is stable right now, downside risks are becoming increasingly more pronounced. These risks are deeply rooted in cyclical and financial factors, but more importantly in policymaking, predicting that the next US recession looms in 2019/20. 

Four of the bank’s most essential downside risks (Protectionism/ trade wars, Sharp market repricing, European policy uncertainty, and China hard landing) are developing into significant threats. They are laid out in the bank’s now iconic “Swan Chart.”

Over the next 12 months, further intensification of the US-China trade war is set to damage global growth, alongside a sharp repricing in financial markets. SocGen said that while the trade war’s impact on global GDP growth remains hard to quantify, it affirmed that global trade and GDP growth will slow as it would increase import prices in economies that levy tariffs or impose quotas.

Global trade volume already weakening 

Global trade index and China export growth has peaked

Naturally, an all-out trade war between China and the US would hurt China in most plausible scenarios, said the French bank. In 2017, the total Chinese exports to the US amounted to just over $500bn, close to 4 percent of China GDP. A 50% reduction in those flows would make a material dent in China’s growth. And with China’s weight in the global economy at about 15%, this would result in a downside shock to global growth. To get ahead of these shocks, Chinese authorities have already scaled back their shadow banking system in preparation for turbulence. 

SocGen then directed their concerns onto “vulnerable” emerging market economies, particularly Argentina, Turkey, Brazil and South Africa, whose currencies have depreciated by 18-20 percent against the USD since the start of 2018. The attention centers on governance and high external foreign-currency debt in the context of a rising USD and US interest rates.

Tightening of US monetary policy and the end of cheap money is also making SocGen more risk-conscious, adding that a dollar shortage has been primarily the culprit of emerging market chaos.

More importantly, SocGen believes that the US rate hike cycle has more to go (hike until something breaks), and the pressuring of emerging market currencies and asset markets could spill over into 2019. Further, the economies that have ignored the emerging market pressure could come under some pressure in the near term, but mentions unless a lot goes wrong, an emerging market financial crisis seems to be contained.

Meanwhile, the repricing risks in developed economies’ equity markets remain a significant threat. SocGen said US stock market indices have continued to set new records, though most other developed economies’ stock markets are down year-to-date, especially in Europe.

The growing gap between US stock markets and the rest of the world was illustrated in Jeff Gundlach’s podcast prior session. 

It is not just SocGen and Gundlach making the case that US equity markets are at or near a top – Morgan Stanley’s latest report showed that “peak” S&P 500 EPS growth projections are set to decline rapidly into 1H19. 

US expansion strong for now, but the next recession looms in 2019/20 

When it comes to the US economy, the only question is when does the sugar high from Trump’s fiscal stimulus expire:

“The slowdown in US growth in late-2017 and early-2018, mild as it was, has indeed also proven to be transitory, and GDP reaccelerated strongly in 2Q. The strength of the rebound exceeded our expectations and hence our US forecast is up by 0.2pp to 2.8% and 1.6% for this year and next, respectively, the latter still substantially below consensus (around 2.6%). Indeed, we expect quarterly sequential growth to slow from here, and year-on-year growth to top out right around the current rate. For US growth, this was probably as good as it gets.

For the next year or so, the US economy will continue to be boosted by tax cuts and higher government spending, SocGen predicts. This, along with solid employment growth, will sustain private consumption growth at a healthy rate well into 2019. Corporate tax cuts may also be a driver of business investment which has been buoyant recently, but the evidence is not clear, given the relatively narrow scope of this spending, much of which went into IT, software and oil drilling.

Ominously, if tax cuts were a major factor of strength in investment, spending would be expected to be broader in scope. More generally, tight supply conditions are likely playing a greater role than the tax cuts, the bulk of which are being returned to investors via stock purchases. 

As for projected US growth, here is the one chart that President Trump hopes will be very wrong as the alternative is “all downhill from here”.

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