Credit impulse flashes a warning to major economies

We fear this is only the beginning. As you can see in the chart below, we have plotted the global credit impulse against the Chinese credit impulse. China’s credit impulse, which roughly represents 1/3 of the global growth pulse, tends to lead the global credit impulse by one year. As long as the Chinese credit impulse does not return to positive territory, we expect the global credit impulse to move downward in the coming quarters leading to lower-than-expected growth. 

The policy response will be crucial in the near term. Due to trade war-related uncertainty, investor belief in a global V-shaped recovery in H2 is growing less certain. We think China is ready and able to further open its credit tap to mitigate the impact of trade war, but this is a challenging task that implies the implementation of very targeted support policy. The goal here would be to avoid fueling the debt bubble as much as is possible. The manufacturing goods sector, most notably the communications sub-sector, represents the largest share of Chinese exports and thus is the most vulnerable to ongoing tensions. It will certainly be subject to support measures very soon.

There is little doubt that China can stimulate its economy, but the same is less certain for the US and the euro area due to policy constraints. In the US, fiscal policy has already been deployed, ultimately fueling a massive federal deficit in a period of growth. The tax cuts had a very strong macroeconomic impact, but the effect could be completely erased if the Trump administration decides to impose a 25% tax on the remaining share of Chinese imports worth $300 billion. Investors expect a lot from the Federal Reserve – bets of a rate cut at December Federal Open Market Committee meeting stand around 60-70%, although it remains quite early to call such a move.

This is also simply not the way that policymaking works at the Fed. We have all noticed the red signals related to the trade war but based on the Fed’s track record, this is not sufficient for a rate cut. At best, we can only really expect a dovish adjustment of forward guidance at this point.  For a rate cut to manifest, we would need a combination of lower inflation, a sharp decrease in consumption and tighter financial conditions, and this is not yet the case. The risk is therefore high that investors will be disappointed by the Fed’s answer to rising trade tensions.

My final word comment concerns the euro area. Potential growth here is lower than in the US, which explains why growth is not higher. Despite headwinds hitting the manufacturing sector, domestic demand is resilient. There is little margin for the European Central Bank to stimulate the economy in case of a pronounced downturn (a new round of TLTRO is clearly not enough) so the only leverage left is fiscal policy, but we have very strong doubts that EU policymakers will be able to reach a common ground on that topic. 

Populist parties, particularly in Italy, are pushing for further fiscal stimulus. This could make sense if we are talking about coordinated productive investments, but they are constrained by the Stability and Growth Pact that should, but probably never will, be reformed. In other words, despite being the second global economic power, the EU is still one of the weakest points among developed markets due to its lack of any real policy response capacity.