As Donald Trump rhapsodised on Tuesday night about the “unprecedented economic boom” he is seeing across America, central bankers in Australia, India and the UK were preparing to join a broader retreat from plans to tighten monetary policy.
Hours after the US president finished his State of the Union address in the House chamber, Philip Lowe, the governor of the Reserve Bank of Australia, stood up to warn of an “accumulation of downside risks” — including trade skirmishes between China and the US, rising populism and Brexit. The next move in interest rates could be down, he said, instead of up.
The Reserve Bank of India, which has been under pressure from prime minister Narendra Modi to ease policy, trimmed rates by a quarter-point a day later. The same day the Bank of England ditched plans for multiple rate hikes. Their dovish pivots followed what was by far the most significant policy U-turn to date: a decision by Federal Reserve chairman Jay Powell on January 30 to shelve any plans to lift rates further because of possible risks to US growth.
The wariness descending over leading central banks is a jarring contrast to the buoyant mood this time last year. At the gathering of business and political leaders in Davos, Switzerland in January 2018, optimism was simmering, with one survey of bosses putting confidence at its highest for six years. The IMF hailed the broadest synchronised global upsurge since the start of the decade, with 120 economies enjoying a pick-up in growth.
That picture has now darkened. An update from the IMF last month bemoaned the “backdrop of weakening financial market sentiment, trade policy uncertainty, and concerns about China’s outlook”. Growth in advanced economies will slow from an estimated 2.3 per cent in 2018 to 2 per cent in 2019 and 1.7 per cent in 2020, it said. Global manufacturing activity is at a two-and-a-half year low.
“You are getting a much more sober assessment of global growth,” says Mohamed El-Erian, chief economic adviser at Allianz.
What has gone wrong? The sea change reflects, in part, a realisation that policymakers became overly bullish last year, says Mr El-Erian. The Fed, in particular, over-reached by signalling four increases in interest rates for 2018 when the global economy was still fragile, he says. Its new-found caution is providing “air cover” for other central banks to mark down their own rate expectations.
The key turning point came in the fourth quarter, when markets suddenly began to wake up to a host of political hazards, including the danger of a further worsening in trade relations between the US and China. That tightening in financial conditions was enough to shave 0.4 per cent from growth in US output after six months, says Isabelle Mateos y Lago, a strategist at the BlackRock Investment Institute. Since then between a third and a quarter of that tightening has been reversed as equities rebounded, but central banks still had no choice but to respond, she says. “It makes sense to lift the foot off the brake.”
The US domestic economy has continued to put in a robust performance, with the number of new jobs in January coming in well ahead of Wall Street expectations and wage growth running comfortably above inflation. But corporate giants in the S&P 500 index, which generate over a third of their earnings overseas, are sounding the alarm about faltering overseas demand in markets including China, where the government has been battling against a slowdown.
Smaller US firms are feeling the global chill as well. Rob Parmentier, president of Marquis Yachts which employs 350 people in Green Bay, Wisconsin, says that while domestic demand is firm, the tit-for-tat imposition of tariffs has clobbered his international business. “It is not getting bad, it is dead,” he says bluntly.
The addition of a 25 per cent tariff on US boat exports to Europe has been punishing. He adds: “It is twofold — not only the tariffs, but Europe has never really come back from their recession.”
The Fed, which led the world’s major central banks in beginning to tighten in 2015, has been at the centre of the recent outbreak of dovishness.
Mr Powell presided over a quarter-point increase in rates on December 19, but his attempts to couple that rise with reassuring messaging about future moves fell flat. The danger sign came when equities were sold off after the chairman repeated well-worn language insisting the reduction of the central bank’s balance sheet will run on “automatic pilot”.
Wall Street’s dyspeptic reaction to his words underscored to policymakers just how fragile market sentiment had become. Business confidence has since been dented by the record-long federal government shutdown while Brexit discussions have floundered.
Moreover, hopes of progress in trade talks with China have sunk as Mr Trump has ruled out a direct meeting with Chinese president Xi Jinping before his March 1 deadline for a deal.
With US inflation as tepid as ever, the Fed has set aside recent worries about economic overheating, focusing instead on what central bankers like to call downside risks. Rate rises are, for the time being, off the agenda. Indeed, if the current ceasefire over trade is reversed, analysts will start asking about rate reductions in the US. Were trade talks between the US and China to break down altogether, accompanied by full-blown hostilities with Europe over auto trade, America could be pushed into an outright recession, according to Deutsche Bank. Its analysts further flag the risks of a sharper Chinese slowdown and a no-deal Brexit.
The mood of unease at the Fed is being mirrored elsewhere. The Australian central bank this week shifted to a more cautious outlook amid concerns that steep falls in house prices and the slowdown in China could choke off domestic growth.
Unemployment in Australia fell to 5 per cent in December, its lowest rate since 2011. But there are growing concerns that a weakening housing market is hitting household consumption, with retail sales unexpectedly falling by 0.4 per cent in December, compared with the previous month.
Evidence of the deteriorating housing market is on show every weekend in Sydney and Melbourne, where once bustling Saturday housing auctions now struggle to attract even a handful of buyers. Just four in every 10 homes put up for sale in December were sold in the traditional roadside auctions. Prices in Australia’s two biggest cities have fallen 12 per cent and 9 per cent respectively from peaks achieved in 2017. Shane Oliver, AMP economist, predicts that prices could fall by as much as 25 per cent from their peak levels.
Stephen King, an economic adviser to HSBC, sees good reason for central bankers to be treading carefully. Of 37 countries he recently examined, only eight have reduced their aggregate debt ratios compared with the beginning of the financial crisis. This means central banks will “naturally be more cautious in raising rates,” he argues. “If you thought the crisis was associated with debt, in some senses we are in a more vulnerable state now.”
Some of the biggest questions hang over Europe. The European Commission on Thursday slashed its growth forecast for this year to 1.3 per cent from 1.9 per cent, marking down outlooks for major economies including Germany. It is now predicting the weakest expansion in Italy for five years.
The European Central Bank has sounded the alarm about the impact of trade tensions and Brexit, only weeks after it stopped expanding its €2.6tn quantitative easing programme.
But Ms Mateos y Lago at BlackRock says she fears the political barriers to restarting that particular stimulus plan are too high for the ECB to hurdle, warning “we are worried the eurozone is not very well equipped to meet a significant slowdown in the economy.”
One of the ironies behind the changing mood among central bankers is that the most prominent U-turn has occurred in what is arguably the most resilient-looking major economy — the US. Bill Dunkelberg, the chief economist at the National Federation of Independent Business, dismisses sombre talk, saying the biggest immediate concern for firms is a shortage of labour.
“It looks like everyone is getting into a tizzy over whether Europe is going to slow down, or India or China,” he says. “That will have some impact for the US, but I think we are getting carried away here.”
Mr Trump, who described the US as “the hottest economy anywhere — not even close,” in his State of the Union speech, would no doubt agree. Some analysts wonder whether, having become overly hawkish last year, the Fed has now overcorrected. The US is relatively less exposed to trade, which in the past has allowed it to avoid importing nasty foreign crises to its own shores.
But as the federal shutdown showed earlier this year, it is also a country that is prone to self-inflicted economic wounds. Potentially destabilising battles loom in Congress over the need to raise the ceiling on the US’s national debt. Meanwhile the clock is ticking on Mr Trump’s trade truce with China.
Having been badly burnt by the market sell-off late last year, Mr Powell is determined to play things safer in 2019 by putting the tightening cycle on hold. For a swelling band of central banks in other parts of the world, there is ample reason to follow suit.