Green shoots?

• After more than a year of ever-weakening global economic data and a particularly difficult stretch over the past five months, investors and analysts alike are on the lookout for green shoots.
• The theoretical support for the emergence of green shoots comes mostly from financial conditions. Whereas financial conditions had tightened significantly over 2018 and were set to cast a considerable shadow over 2019 growth, they have since eased due to the recent dovish pivot by central banks. The drag isn’t actually gone, but the negative impulse isn’t as bad as forecast at the end of 2018, and the peak drag on growth has arguably already past. To be clear, growth over the remainder of 2019 will continue to be weighed by financial conditions, but to a gradually diminishing degree (presuming no sudden change in financial conditions from here).
• The empirical side of looking for green shoots – tracking and interpreting data – is harder than usual right now, complicated by the seasonal distortions of Chinese New Year, a longstanding (but structurally diminishing) Q1 seasonal drag in the U.S., and the temporary damage of the U.S. government shutdown. These make it more difficult than usual to assess whether growth is slowing, stabilizing or accelerating in the world’s two major markets.
• A few tidbits of data are promising:
  • Some (mostly proprietary sell-side) current activity indices have edged slightly higher, though certainly not all have (the Chicago National Activity Index continues to fall, for instance).
  • Individual U.S. data points such as jobless claims remain strong, and certain measures such as core capital goods orders have rebounded. Aggregating all of this, the Atlanta Fed’s GDP tracker has increased its Q1 projection from less than 0.5% growth to the current reading of +1.6%. Neither is good, but the upward trajectory is welcome.
  • China continues to deliver stimulus, and some leading indicators point to a stabilization in growth there.
  • The global stock market has rebounded substantially since the start of the year. While some of this is an instinctual response to dovish central banks, some presumably reflects upgraded growth expectations due to the extra monetary support. Regardless of motivation, higher stocks create a positive wealth effect.
  • Base metal and oil prices have been rebounding since last fall. The former, in particular, is a classic signal of economic demand.
• These developments are constructive and merit recognition.
• However, it is not the full story. There is still a powerfully negative narrative that also demands attention.
• On the theoretical side, U.S. fiscal stimulus has faded substantially relative to last year and the drag of protectionism has strengthened. Similarly, downside risks such as the aging business cycle (and an ominously inverted yield curve) substantially outweigh upside risks.
• From an empirical perspective, the key sources of worry are that PMIs are mostly still falling. U.S. industrial production also continues to roll over.
• Weighing the good against the bad, the proper conclusion at this juncture is that economic developments are no longer uniformly negative. This is notable, and welcome. However, it seems premature to suggest that growth is actively rebounding. Stay tuned.
  -With contribution from Vivien Lee

Chinese stimulus:

• The Chinese government has responded to the country’s slowing growth in a variety of ways.
• China has accepted that as it becomes more prosperous, it cannot realistically grow as quickly as in the past. This is reflected in the country’s new 6.0% to 6.5% growth target, down from earlier projections. The downgraded outlook also reflects China’s desire to avoid re-inflating the debt excesses that so worried the world just a few years ago.
• While acceptance is part of the answer, China is also trying to prevent GDP growth from descending even further. A regimen of monetary, regulatory and fiscal stimulus has been delivered, though on a scale smaller than that of 2009 or 2016.
• Estimating the fiscal impulse for China is more challenging than for the developed world, for two reasons:
  • First, much of China’s stimulus does not show up on the official federal balance sheet. Only a limited portion comes in the classic form of a bigger federal deficit. Much also sneaks forth via additional local government borrowing, off-balance-sheet activities and additional bank lending.
  • Second, whereas Chinese stimulus in the past was mostly in the form of infrastructure – easy to target and the money indisputably makes its way into the economy – the latest round of stimulus has tilted more toward tax cuts. These have a less certain effect, particularly given the notoriously high savings rate of Chinese households. The fiscal multiplier is especially uncertain, and potentially lower than usual.
• With all of this is in mind, how big is China’s stimulus package? To some extent, any answer is premature, as the country will likely announce additional measures.
• The stimulus is undoubtedly larger than the projected increase of a couple of tenths of a percentage point in China’s official fiscal deficit (from 2.6% of GDP in 2018 to 2.8% of GDP in 2019).
• Bottom-up approaches argue that the stimulus is bigger than this. For instance, China’s corporate VAT tax cut alone should cost around 0.6% of GDP and be reflected in the official fiscal deficit. This is hard to reconcile against the government’s own forecast for a mere 0.2ppt increase in the official fiscal deficit, suggesting that there must be offsetting fiscal restraint elsewhere, perhaps in the form of more stringent tax collection or a reduced civil service headcount.
• More comprehensive estimates that reflect local government programs and off-balance-sheet borrowing (called the augmented fiscal account) point to stimulus of as little as one percentage point of GDP to as much as three percentage points. Most estimates tilt toward the lower end of this range.
• Even at the high end, this is no more than half the stimulus delivered in response to the country’s 2016 slowdown. Thus, the discussion should be more about economic stabilization than an outright rebound.
• Recall also that the stimulus could prove less effective than usual due to the way it is being disbursed, resulting in less of a boost than the fiscal stimulus estimates above.
• Tallying up the size of fiscal stimulus doesn’t provide a full accounting of government support, of course. Monetary stimulus and regulatory changes don’t cost money (directly, anyhow) and yet can also boost growth.
• On the other hand, China is grappling with several headwinds, including the country’s slowing housing market, deteriorating competitiveness and poor demographics. Global demand is also an important consideration and skewing more negative than positive.
• At this point, the Chinese economy seems likely to stabilize in the second or third quarter of the year, though we do not expect much of an acceleration. The country’s prior credit excesses and ongoing deleveraging effort limit the forcefulness of stimulus efforts. Without the stimulus, the country would have likely continued to decelerate to sub-6% growth.
  -With contribution from Vivien Lee

Brexit update (yes, again):

• With the caveat that everything written here will become stale in a matter of days if not hours, here is a brief Brexit update.
• Having thrice rejected Theresa May’s transition deal and wrested control of the process from the government, British parliament held eight indicative votes over the past week to evaluate the main Brexit options.
• Unsurprisingly given the sheer number of choices, none captured more than 50% support. As such, there is no single path forward. Note that parliamentarians were allowed to vote in favour of more than one option, so the totals sum to well over 100.
• The votes were nevertheless instructive.
• For one, they tell us which options are unpopular, and so quite unlikely to be pursued. Unpopular options included remaining within the European Economic Area (a very soft version of Brexit – just 15% support), depart without a deal (hard Brexit – 29% support), and revoking Article 50 (cancelling Brexit altogether – 39% support).
• The votes also tell us which options were least unpopular, meaning that a path could conceivably be cleared toward the outcome. Two jump out.
• First, a permanent customs union received 49% support among voters (though, as with all of these votes, not all parliamentarians voted on each one and so it is equally correct to note that just 41% of all theoretical voters endorsed the option). We have long viewed this as the most likely outcome, and continue to see it as such. It would permit goods to flow freely between the U.K. and EU, minimize the border between Northern Ireland and Ireland and yet allow the U.K. to control immigration.
• Second, the option of holding another referendum to get greater clarity from the public received 48% support among voters. As with the others, the figure is lower when framed in the context of the fraction of potential voters (41%), but it is notable that this option received the most “yes” votes of all the choices. Of course, a second referendum is not an outcome in itself, but rather a waystation through which an eventual decision would proceed. Much would depend on the precise question asked in a referendum (whether, for example, it provides the option of “No Brexit”, or simply lays out a menu of ways to leave, or even asks the public for a yes/no vote on whatever option parliament recommends. Given public polling, we are inclined to think that either “no Brexit” or a fairly soft version of Brexit such as a customs union would likely be selected.
• We suspect the path forward will involve another round of indicative voting. Several of the options were close enough to 50% support that simply repeating the votes could elicit sufficient support now that everyone knows which options are truly in the running. For that matter, the voting may be re-held with the least popular options removed, further concentrating the vote.
• For now, the Brexit deadline has been extended to April 12th. Absent a deal by then, the EU says it is willing to delay a resolution into May, but not past the EU elections that occur late in that month. At present, it looks as though a longer delay than that may be necessary. While the EU is reluctant to grant this, its bluff will likely eventually be called as it is now looking logistically quite difficult to arrive at a coherent Brexit decision in time.

Data run:

• Canadian GDP (Jan): Canada’s monthly GDP series rose by 0.3% in January, its best monthly gain in eight months. The performance was all the more impressive given that the mining/energy sector was down substantially, in part due to mandated oil production cuts in Alberta. To the extent those cuts have since lessened, it stands to reason that the sector’s drag should diminish in the coming months. Ultimately, January managed its solid gain thanks to gains in manufacturing and construction. The latter, in particular, doesn’t seem likely to persist given broad-based weakness in residential real estate. It is worth putting this increase into perspective – three of the prior four months suffered declines, arguing that the Canadian economy is still in a tough position. Our leading indicator aggregate for the economy remains weak and has been on a downward trajectory. Tallying this up to a quarterly frequency, Canadian Q1 GDP is now tracking somewhere in the 1.0% to 1.5% annualized range, a little higher than last forecast by the Bank of Canada. However, a hawkish turn from the Bank seems unlikely given that its fourth quarter forecast was too optimistic by nearly a percentage point.
• U.S. payrolls preview: Recall that U.S. payrolls rose by a mere 20K in February, representing a sizeable miss versus expectations and the weakest performance in years. Our best guess is that the February report was an outlier given that it substantially undershot the readings provided by the ADP and household surveys, plus that of jobless claims. Note also that the unemployment rate fell to just 3.8% and wage growth surged. These are not the accoutrements of a weakening labour market. To be fair, we shouldn’t expect March to fully counter February’s weakness, as some of that was in turn the result of unusual strength in January. But the bottom line is that a much more normal looking employment report is likely for March, perhaps even above the +178K consensus.
• Canadian employment preview: In something of a reversal of the U.S. situation, Canadian job creation has been unsustainably strong in recent months. While the happy January GDP print appears to align with that pattern, a more careful examination would concede that the economy has been quite weak. In turn, our best guess is that some of the recent strength will have to be relinquished in March, pointing to a minimal job gain or even a loss.