Turbulent autumn is coming

The timing is symbolic. Ten years after the financial crisis tensions are building up in the global economy. One can undoubtedly explain this, at least partly, by emotions and psychology. However, a number of recent economic developments raise fundamental questions about the sustainability of the current economic context. The massive liquidity in the world, resulting from unconventional expansionary monetary policies, stimulated risk taking among investors, governments and consumers. Against this background, a minor economic shock could trigger a major disruption.

In Europe, the ECB aims to close the crisis decade symbolically by a gradual normalization of monetary policy. At several occasions in the past we emphasized that financial markets may react nervously on this policy switch. More precisely, one cannot exclude that long term rates will rise fast. An upward movement in the German long term bond rate is currently prohibited by concerns about other European economies. In particular, concerns about the expected Italian budget dominate the markets. The new Italian government’s intentions are not fully clear and a clash between the Italian government and the European Commission on European fiscal rules may be unavoidable. The possibility that the Italian government won’t obey the European rules has already increased the Italian-German bond rate spreads (currently about 250 basis points). This signals commotion and leads to renewed concerns about the future of the European Monetary Union. Ultimately we expect the Italian government to stick to the European rules. However, this may not be the case immediately. Next to the Italian concerns, an East-West confrontation is building up in Europe. Critical voices in Eastern Europe on the future direction of European policies, and vice versa Western European criticism on Eastern European political decisions, raise many, currently unanswerable questions about the future coherence of the European Union.

In the meantime, negotiations on Brexit aren’t going smoothly at all. The political chaos in the United Kingdom makes it impossible to determine a clear British perspective in the negotiations with the EU. At the same time, the EU currently appears to be reluctant to engage in the ongoing British political debate, leaving basically nothing on the negotiation table. Valuable negotiation time is being lost, which is detrimental given the complexity of the entire Brexit operation. Therefore it has become clear that Brexit won’t be smooth at all. Nevertheless, this doesn’t automatically imply a disaster scenario with a hard Brexit. The latter outcome would be disastrous for the United Kingdom and the EU. We expect augmenting pressures from European and British businesses to force politicians to strike a deal. Anyhow, such a deal has to be concluded this fall in order to be able to finalize the entire divorce procedure before the exit deadline. Given the time pressure and the substantial divergence of opinions, a turbulent discussion can be expected this autumn.

A number of international trade conflict still go on. In particular, the confrontation between the US and China has an enormous economic impact. De-escalation seems to be out of reach. The consequences will be mainly felt in the long run as economic growth will slow down, productivity will drop and unpredictable international trade and investment dynamics will set in. At this moment these uncertainties weigh on economic sentiment and therefore on actual economic performance. For now, a ceasefire has been achieved in the bilateral trade tensions between the US and Europe after the informal deal between Commission President Juncker and President Trump. However, little is needed to disturb the fragile relationship again. President Trump’s negative trade rhetoric is likely to reach a (temporary) peak in the coming weeks as we approach the mid-term elections for the US Congress and Senate. By a number of harsh statements on international trade and investments, the president intends to influence the American public opinion. The unpopular NAFTA agreement seems to be dead and buried, while we’ll have to wait and see whatever succeeding agreement can be reached.

A number of emerging economies already experience stormy weather. So far the countries involved, like Turkey, Argentina and Indonesia, are no surprise. Each of them have run into troubles due to their high reliance on external financing, often combined with clear political aspirations, that are incompatible with a context of increasing interest rates and a strong(er) US dollar. More victims are expected. The main question is whether these negative developments will spill over to a wider group of emerging markets. Currently this is not yet the case, but even the possibility raises serious concerns.

Despite the many risk factors, there is also potentially good news this autumn. If these events proceed more smoothly than currently anticipated, it may be considered as positive surprises. In the end, the Italian government may decide to follow the EU fiscal rules, while trade tensions may be reduced by successful negotiations. However, it all remains to be seen.
Clearly, there are many reasons why the autumn of 2018 might be a turbulent period. Temporary volatility is, however, not always bad. It might be a wake-up call that in the long run basic economic principles will determine sustainable economic developments. Excessive economic stimulus, extreme liquidity or unlimited risk appetite are definitely not sustainable. Sooner or later the other side of the coin will become clear. Many of these topics raise questions and require further economic analysis. During the following month, the KBC Economic Opinions will again inform you, our loyal readers, with clear explanations and original interpretations. We already wish you a nice, and hopefully calm, autumn season.