Concern over a series of global economic risks plunged financial markets into turmoil at the end of last year. The ongoing threat of an escalation of the US–China trade dispute and fears over China’s domestic slowdown reducing demand in the rest of the world, coupled with worries about an overly hawkish US Fed and other geopolitical events (US government shutdown, postponement of UK Commons Brexit vote) led global equities to drop, with the MSCI world down 7.7% and US stocks experiencing their worst December since the Great Depression. As Fathom’s proprietary Economic Sentiment Indicators (ESIs), which provide an estimate of underlying sentiment from a range of consumer and industry surveys show, these worries spilled over from financial markets into the wider economy in the US and Japan.
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Our US ESI fell from 5.8% to 4.6% in December. This was the lowest reading since July 2017, and the decline during the month was large by past standards. That said, we think that too much pessimism has been priced into financial markets. Despite the fall in the US ESI last month, sentiment is still strong by historical standards and December’s blockbuster employment report suggests that the economy is still growing at a solid clip and above potential. For now, we think that external shocks, such as a slowdown in China, are likely to have a relatively small effect on the US real economy. We still think a US-led global recession is likely within the next couple of years, but that this is unlikely to happen in 2019 and it would take a much larger drop in the US ESI for us to alter this view.
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Meanwhile, the Japan ESI remained broadly stable throughout 2018 Q4, but fell from 3.9% to 3.6% in December. The broader-based business surveys remained supportive, but both the manufacturing and consumer sectors showed signs of weaker sentiment. The export-driven manufacturing sector, in particular, seems to be suffering from slower Chinese economic growth and trade war uncertainties, as highlighted by the chart. The threat of US auto tariffs will continue to loom at least until next month, when the US Department of Commerce decides whether protectionist measures against US automobile imports could be justified on national security grounds.
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Unlike the US, Japan’s economy is far more dependent on exports, and the recent falls in the trade balance will weigh on economic growth. While we expect a rebound in Japanese GDP growth in Q4 following a contraction in the previous quarter, continued weak external demand and signs of a softening domestic sector suggest that growth will remain subdued.
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