By Jean-François Perrault
Developments in recent weeks serve as a stark reminder that the central economic and financial thesis of the last year remains unchanged: uncertainty is here to stay so long as President Trump remains in office. For much of the last year, markets have been waiting with bated breath for indications that there might be a truce in the costly trade war between China and the United States. As a reminder, we estimate that the trade war reduced the level of U.S. economic activity by three-quarters of a percentage point relative to a situation in which uncertainty was at historical levels.
The hope, in some quarters, was that a deal between China and the U.S. on the trade side, as seems likely to occur on January 15, would usher in a period of lower uncertainty, greater stability, and greater confidence. As a result, global trade activity might pick up, along with industrial activity and other business activity. This is a hopelessly optimistic take. A few days into the New Year, President Trump reminded us that event risk will remain a feature of his presidency. At this time, we view developments with respect to Iran as less important from a direct economic and financial perspective, but very important from an uncertainty perspective. President Trump is an erratic politician, prone to statements or actions that can destabilize sentiment and markets.
Moreover, as we have noted in the past, while trade-related uncertainty will be lower than the peaks observed in 19Q3, it will remain elevated so long as President Trump is in office. The U.S. trade deficit remains significantly larger than when he took office. His mission to shrink the trade deficit is far from accomplished, and we expect continued drama on the trade front: perhaps more aggression towards Europe, the issue of auto tariffs remains in suspense, and we can’t even be sure that deals that have been negotiated and ratified will be respected.
As a result, we take comfort in the détente between China and the U.S. on the trade front, but this development has no tangible impact on our view, other than reducing a major tail risk. We continue to believe a modest expansion will continue in much of the global economy, though we have yet to be convinced that the green shoots observed in Europe are indicative of a fundamentally stronger economy.
In the North American context, growth in Canada and the U.S. is expected to fall relative to 2019, though we have marked down our Canadian forecast relative to our last publication owing to a very weak ending to 2019, which affects growth dynamics in 2020. While some of this weakness is attributed to the GM and CN Rail strikes and pipeline outages, the Canadian job market weakened considerably at year-end, and consumer confidence has fallen sharply from late summer readings (to a three-year low, and in a manner that is inconsistent with the general state of the economy). This suggests there is considerable risk that growth may remain weak early in 2020. Perhaps most importantly, the decline in confidence is actually increasing the odds of a Canadian recession despite the steepening of the yield curve in recent months and the truce in the China-U.S. trade war. We still believe a recession in Canada (and the U.S.) is unlikely, but it is clear that Canadian households are much less confident in the outlook now than they were three or four months ago.
Given that downside risks remain elevated in the global economy, and are rising in Canada, we continue to believe some policy easing will be required in the U.S. and Canada. In the U.S., we think 25 basis points will be required around mid-year, whereas we think there is a bit more urgency in Canada. We think the Bank of Canada will trim rates by 50 basis points owing to downward pressure on inflation coming from the weaker outlook, and to guard against the possibility of a more dramatic slowdown if consumer confidence continues to deteriorate.
Jean-François Perrault is Scotiabank's Senior Vice-President and Chief Economist. Read Scotiabank Economics' full Global Outlook here.