Vanguard economic and market update
27 September 2019 | Markets and Economy
Vanguard's key points:
- Investors around the world are starting to worry that recession may be on the horizon.
- Nothing lasts forever, of course, and economic cycles inevitably end.
- We don't know when the next recession will begin, how long it will last, or to what degree it may affect investment returns.
- We do know that Vanguard's principles for investing success give investors sound guidance for any investing environment.
- Vanguard has changed its base case for the Bank of England's (BoE) monetary policy to no interest-rate cuts for the rest of the year. The significantly decreased prospect of a no-deal Brexit, a greater chance of expansionary fiscal policy, and better-than-expected recent economic data led us to change our view. The BoE last week voted unanimously to keep its bank rate at 0.75%.
- As Vanguard expected, the European Central Bank (ECB) cut the interest rate on its deposit facility by 10 basis points to –0.50% on 12 September. In doing so, it changed its previous guidance that rates would remain at current levels or lower until at least mid-2020. Instead, it tied its policy to the inflation outlook—and revised its inflation outlook lower through to 2021. The ECB additionally said it would restart its asset purchase programme, or quantitative easing (QE), at a monthly pace of €20 billion starting on 1 November, 2019. That was less than the €30 billion per month that Vanguard had anticipated. But in a dovish move, the ECB said it would continue QE for “as long as necessary.” Given the muted inflation outlook, Vanguard believes that negative ECB rates and QE are here for the foreseeable future, with risks skewed toward a faster pace of QE should the macroeconomic outlook deteriorate further.
- The US Federal Reserve cut the target for its federal funds rate by 0.25% last week, to a range of 1.75% to 2.0%. Vanguard sees the move as the second of two cuts intended to inoculate a resilient US economy from weakness elsewhere and geopolitical concerns. Vanguard believes that the Fed won't make further policy changes for the rest of the year.
- Vanguard believes that cuts this month by the People's Bank of China to financial institutions' deposit reserve requirement ratios are unlikely to spur a significant increase in lending.
- The Bank of Japan (BoJ) announced last week that it was keeping its key short-term interest rate at –0.10% and its target for 10-year government bond yields at around 0.0%. Vanguard's base case is for no BoJ policy change in October, but with the potential for further BoJ easing beyond that, dependent on the re-emergence of yen appreciation against the US dollar and global economic risks.
Vanguard expects global growth to continue softening over the next 12 months amid trade tensions and policy uncertainty. The risk of a global or major regional recession is not Vanguard's base case, but is more elevated than normal.
- Vanguard's baseline case for China for the next 12 months sees the government delicately balancing growth and financial stability, tilting toward the former as external headwinds to growth intensify.
- Vanguard's view on growth elsewhere is unchanged from the August update. We see second-half growth in the United States at 1.7% (annualised) and full-year growth closer to 2.0%, with US-China trade and geopolitical tensions as the key risks.
- In the euro area, Vanguard continues to see 2019 GDP growth at 0.8%. We place a 35% to 40% probability on a euro area recession in the next 12 months. Germany, in the midst of a manufacturing slowdown, recorded negative growth in the second quarter. Contraction again in the third quarter would put the euro zone's largest economy in a technical recession.
- In Japan, we see 2019 growth below trend at 0.6% amid global trade tensions and a planned October increase in the domestic value-added tax.
Recent developments have ensured that UK Prime Minister Boris Johnson will be required by law to seek an extension to Brexit if no deal has been agreed with the European Union by October 19. Should a deal not be reached and the UK's exit be delayed, Vanguard sees the likelihood of a general election being called for late November or early December 2019, ahead of an expected new exit date of 31 January, 2020.
- The ISG research paper It's not EU, it's me: Estimating the impact of Brexit on the UK economy presents Vanguard's findings on the potential effects of Brexit under a variety of scenarios.
The US-China trade picture has brightened in recent weeks, with talks scheduled for early October amid signs that both sides are willing to delay and/or reduce previously announced and imposed tariffs. But Vanguard still sees a permanent tariff regime as our base case, owing to hard-to-resolve structural issues around US access to Chinese markets and the forced transfer of US technology to Chinese companies.
Despite growth concerns, Vanguard expects labour markets to remain relatively tight and unemployment rates to remain stable in most major economies.
Vanguard's outlook for global inflation is mixed, as our weaker global growth outlook is offset by upward pressure from tariffs.
This document represents the house view of the Investment Strategy Group's (ISG's) global economics team as of 23 September, 2019, on a number of economic and market topics.
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