Global Outlook: Deflation is Back... (but)

It's that D-word again. Deflation is knocking at the door of the global economy. But who is going to answer, and who is really at the door? (and so what??)

In the following charts and paragraphs I will provide my take on the key drivers, the response, the ripple effects, and a base case scenario for how it plays out heading into 2020.

First up is a trusty chart I came up with a few years ago. It shows the proportion of countries experiencing "deflation" (i.e. negative growth year over year) across consumer price inflation, corporate earnings, and industrial production. After the deflation dissipation of 2017-18, a new deflationary wave is sweeping the globe.

global deflation monitor

Consumer price deflation is one thing, but economic deflation is another. Consumer price deflation is typically driven by falling commodity prices, that is unless there is an accompanying economic deflationary impulse.

From a cyclical standpoint, the considerable monetary policy tightening across the globe in 2018 and effective trade policy tightening from the trade wars have really been the major elements behind this economic deflation, and it is in understanding how we got here that we can begin to understand the key drivers, what to watch for, and the next steps.

Deflation Drivers: Monetary Policy Tightening

The first and most overlooked aspect is how significant the monetary tightening of 2018 was. You can see in the chart below a 9-month period where there were exclusively rate hikes. At the same time the ECB was tapering QE, the BOJ did stealth taper, and the Fed was doing quantitative tightening. The patient was taken off life support...

global monetary policy pivot

Coming out of a world that had gotten used to ultra low interest rates and super easy money, this tightening of policy (and if you recall, a surge in bond yields) really took a bite out of the global economic cycle. And now central banks are furiously backpedaling.

Deflation Drivers: Trade Policy Tightening

The other key policy act was effectively a tightening of trade policy across the globe as Trump made good on election promises to stir up the global trade order... and stir up he did.

The China-US trade war (which is not the only game in town, multiple tit-for-tat trade disputes have followed across regions, and not just with the US). Anyway, the chart below provides a good gauge of the impact of the China-US trade war, where Chinese manufacturing trade orders have stagnated, and more recently have likewise collapsed for US manufacturers.

global trade orders: trade war impact on China and USA

We can probably go around in circles pointing the finger at what the main driver is, but it's fair to say the headline shock and uncertainty aspect, along with tariff hikes and renegotiations have only compounded and added to the headwinds of monetary policy tightening last year.

US Economic Slowdown and the Powell Policy Pivot

The US economy has been far from immune to the global slowdown, and you can see the US manufacturing PMI swiftly catching down to global ex-US. Both the ISM and Markit PMIs are pointing to a significant slowdown in US GDP growth. So what we have here is the US economy clearly exposed to global risks, and likely softer growth ahead.

US economic recession risks in 2 charts