Econosights – Five Global Risks to Watch

(AMP Capital)

 

  • The global economic upswing is expected to remain in place for now which is good news for growth assets.
  • But there are still plenty of downside risks to the growth outlook. We explore five key areas we are watching.


Introduction

We remain positive around the outlook for the global economy over the next year. But there are still numerous downside risks to growth that could cause issues for individual economies and spread globally, as well as impacting share markets. We outline our top five global risks to monitor in this Econosights.


Lack of progress in Euro area reforms

The Eurozone economy has enjoyed a strong cyclical rebound over the past year, with a clear convergence in growth across countries. Structurally, the Euro area also looks more stable, with an improvement in government debt, current account deficits and unemployment rates. Positivity around the future of the Euro area was further elevated with the election of pro-EU President Macron in France who campaigned for centralised reforms to strengthen the Euro bloc. But, there have been some recent setbacks which may delay any type of broad Euro reform.

Firstly, the new German coalition government (between Merkel’s Christian Democrats and the Social Democrats) have proved to be more fiscally conservative than anticipated and less willing to cooperate with Macron’s proposals. The second setback is the outcome of the Italian election, which has resulted in a coalition government between the populist parties of the far-right Northern League and the left-learning Five Star Movement. Both parties lean towards Euroscepticism and current proposed policies include a roll back of pension reform, income tax cuts and a modification of EU fiscal rules which are negative for the Italian economy in the long-run. Inherent Euroscepticism evident in both parties is a longer-run risk that needs to be monitored. For now, there are no signs that the government is planning to hold a referendum on EU membership.

Euro leaders meet in late June to discuss key issues around Euro reforms including changes to the European Stability Mechanism (scheme designed to help indebted countries), a Euro deposit insurance scheme to protect bank deposits and providing more funds for failed banks. Expectations around agreement on these issues are low which is disappointing because the strength in the Euro economy now means that reforms should be done sooner rather than later. Reforms are important to increase potential growth and sustainability of the Euro area. The risk is that reforms are delayed too far into the future at a time when growth is slowing. There is clearly more that needs to be done to lift household sentiment, with trust in EU institutions low (see chart below). But, households still have more trust in EU institutions, compared to national counterparts.


Source: Eurobarometer, AMP Capital


US debt build-up part 1

In history, economic expansions and an easing in interest rates have tended to lead to an excess of debt across sectors. These excesses later cause problems when economic growth starts to slow. In the US, years of low interest rates have contributed to some lift in corporate debt (still below pre-GFC levels) while household debt growth has been lower (see chart below).


Source: FRED database, Reuters, AMP Capital

US corporate spreads are very tight, reflecting the “search for yield” environment. Investors are probably too complacent around future risks in the corporate sector, particu