TD Economics: Quarterly Economic Forecast – 'Tariffs Impart a Chill Wind on Green Shoots'

On Monday, TD Economics published its Quarterly Economic Forecast, entitled "Tariffs Impart a Chill Wind on Green Shoots." Below is the executive summary of that report. The full report can be found here.

Global economy: At a crossroads

The global economy has been unfolding largely as we had anticipated in March. Following last year’s steep deceleration, high-frequency indicators suggest that global growth has stabilized, albeit at a below-trend rate of just above 3%.

Next year, however, the growth outlook has been downgraded by 0.2 percentage points to 3.3%, in part reflecting the recent escalation in trade tensions.

Signs of bottoming in growth so far this year have reflected a mix of factors. Recent trade-induced gyrations aside, global financial conditions have eased broadly so far this year, driven in part by expectations of lower policy rates. This and other stimulus measures – notably in China – have supported a firming in economic activity. Green shoots have appeared across emerging Asia as well as a number of advanced economies, including core Europe and Canada.

The overall picture masks a continued divergence between manufacturing and service sectors. Global manufacturing activity remains in the doldrums, largely related to trade uncertainty and the knock-on effects of declining auto production in Europe. In contrast, service industries have remained comparatively resilient, particularly in advanced economies.

Trade tensions represent a clear and present danger to the global economy going forward. Our outlook embeds tariffs that have already been implemented, but the threat of further actions – and potential for an unexpected severe bout of risk aversion – remain key downside risks to the forecast.

Canada economy: Between a rock and a hard place

Canada’s economy has been mired in a soft patch, with real GDP growing just 0.4% (annualized) in the first quarter, following 0.3% in the final quarter of 2018.

In Canada, real GDP growth is expected to average 1.3% for all of 2019, before strengthening to a trend-like 1.7 in 2020.

The weakness in broad output trends has concealed a better story underneath the surface. Notably, domestic demand (spending by households and businesses) rebounded in Q1 and the job market has remained resilient. However, the external backdrop continues to deteriorate in the wake of ongoing trade disputes.

We expect the gap between soft real GDP growth and robust job growth to close over the next few quarters, as output growth picks up somewhat while employment eases to a more sustainable pace. For 2019 as a whole, we anticipate a 1.3% real GDP expansion, while the unemployment rate remains below the 6% mark.

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It is not assured that the Bank of Canada will follow the Federal Reserve, as markets so often expect. Absent clear evidence of domestic economic deterioration, easing in Canada is unlikely. We hold this view for several reasons.

First, after an extended soft path, the domestic data is now coming in better than expected in Q2, tracking 2%. This is above the Bank of Canada’s expectation. Housing is showing signs of stabilization, and the Bank will want to avoid the risk of re-fuelling leverage dynamics. Third, the policy rate is already lower relative to south of the border.

U.S. economy: Outperformance, but risks loom

U.S. economic growth outperformed expectations early in 2019. Real GDP advanced at a 3.1% (annualized) pace in the first quarter, boosted by temporary factors including a significant inventory build. With some reversal, growth is expected to slow to 1.9% in Q2. Still, the first half of the year is tracking 2.5%, roughly a half a percentage point above our prior expectation.

U.S. economics growth outperformed expectations early in 2019. Real GDP advanced at 3.1 (annualized) pace in the first quarter.

This places the 2019 annual average at 2.5% (previously 2.4%). Economic growth is expected to slow to 1.8% in 2020, as capacity constraints bind.

The White House has raised its tariff rate from 10% to 25% on the second tranche of Chinese imports subject to tariffs. Taken by itself, the impact is likely to be relatively small (we estimate a little over 0.1 percentage points), but much will depend on how spending and investment reacts to the continued ratcheting up of trade conflicts. Manufacturing sentiment has already begun to converge to lower levels seen abroad. This raises the prospect that another round of tariff action could have a larger impact on economic growth and sentiment relative to last year when both were at higher starting points.

Markets are pricing as much as four rate cuts between now and the end of 2020. This aggressive positioning reflects worries of further tariff escalation alongside low inflation and slowing economic growth (both globally and domestic). We believe the market has over-priced the extent of accommodation the Fed will ultimately need or be willing to provide absent a significant deterioration in the economic data. However, the persistent elevated risk environment opens the door for the central bank to take a risk management approach and provide a modest accommodation (50 basis points in cuts) later this year as “insurance."

We expect some semblance of a deal with China to occur this year. Critical to this outcome will be developments that occur from discussions between President Trump and President Xi at the G-20 meeting at the end of June. However, even in the event of a trade deal, it’s unclear at this stage whether the weight on the economy and market sentiment would fully lift. Importantly for the former, a deal would need to unwind the 25% tariffs placed on China in May. In addition, global trade concerns may quickly return to the spotlight with Trump having already signaled a desire to quickly pivot to Europe (a larger export market for the U.S.).

Contributing authors: Beata Caranci, Derek Burleton, James Marple, Fotios Raptis, Leslie Preston, Brian DePratto, James Orlando.


Beata Caranci

Senior Vice President and Chief Economist

TD Bank Group