By Christopher Dembik, Head of Macro Analysis, Saxo Bank

02 February 2019 - Dubai, UAE

The global credit impulse is falling again, mainly in developed-market economies and due largely to the normalisation of monetary policy. The message from the slower credit impulse is that growth and domestic demand are headed for a slowdown, unless the world’s largest economies launch a massive coordinated intervention in 2019.

“Bearish signs for the US economy are accumulating and will eventually push the Federal Reserve to pause monetary policy for at least Q1 2019 and even longer”

“China is the main positive contributor to global credit impulse”

“Close to zero without China”

Global credit impulse — the second derivative of global credit growth and a major driver of economic activity — is falling again, running at 3.5% of GDP versus 5.9% in the previous quarter. Currently, half of the countries in our sample, representing 69.4% of global GDP, have experienced a deceleration in credit impulse. 

With some notable exceptions, such as the US, Japan and the UK, lower credit impulse is mostly observed in developed markets while emerging markets experience a significant increase in the flow of new credit. Higher credit impulse in EM countries can be interpreted as a direct consequence of the measures taken to support economic activity to face ongoing headwinds (lower liquidity, higher USD funding costs and deteriorated financing conditions). 

By contrast, the more negative trend observed in DM countries is largely due to the normalisation of monetary policy. In the euro area, credit impulse is still subdued and close to zero, indicating that a new and more restrictive credit cycle has just begun. The message from the global credit impulse is basically that growth and domestic demand, which is highly correlated to credit impulse, are doomed to decelerate, unless a massive coordinated intervention of the world’s largest economies occurs in 2019.

China, the global credit engine

Like in the previous quarter, China is the main positive contributor to global credit impulse. Excluding China, the global credit impulse would come close to zero. China’s stimulus represents 34% of global growth, which is equivalent to the combined contribution of the US and the Eurozone, and about 70% of Asian EM manufacturing growth. China’s credit impulse has been revised upward, at 7.4% of GDP in the previous quarter, the highest level since 2013, and is currently slightly lower at 6.6% of GDP. 

We expect that credit impulse will remain strong in coming quarters as China’s focus is moving towards greater economic support to mitigate the impact of trade war. A large-scale fiscal and monetary stimulus is probably off the table given policymakers’ worry about yuan stability. However, the likelihood of new market-opening policies, including tariff cuts on more goods and a cut in banks’ reserve requirement ratio, is high in the first quarter of 2019. 

Country-by-country: where are we heading?

In the appendix, we show updated data for the credit impulse for our sample of 18 countries. In this edition, we focus on four countries: the UK, the US, Australia and Japan.

UK downside risks remain high

The UK’s credit impulse has been one of the lowest in the DM countries, but it has recently returned to positive territory. However, the impulse is too little and too late to be optimistic about the UK economy in 2019. Growth is expected to decelerate further, though remain above potential. All the other leading indicators also point to downside risks as Brexit anxiety is mounting. 

The UK OECD leading indicator, which is designed to anticipate turning points in the economy six to nine months ahead, fell in October for the fifteenth straight month. The year-on-year rate started the year at minus 0.6%; it now stands at -1.34% – quite a swing over 10 months! In addition, new car registrations, which are viewed as a leading indicator of the wider economy in the UK, have been tracking downwards since 2016, driven by falling consumer confidence. Over the period, new car registrations fell to 2.3 million from 2.7 million – a stunning drop of 15% in just 20 months. The downward trend has accelerated in recent months as the perspective of a no-deal Brexit increased. 

Though the risk of recession is limited in 2019, our view for the UK economy is very negative since all the possible post-Brexit scenarios will be worse than staying in the European Union. 

US economy set to decelerate

As noted earlier, the US credit impulse has rebounded to 0.7% of GDP versus -1.1% of GDP in the previous quarter. This acceleration can be partially explained by strong demand in commercial and industrial loans and leases since the beginning of 2018 and confidence in the economy expressed by strong private investment and linked to Trump’s tax reform. 

However, these factors will not last long and credit impulse along with GDP growth are expected to decline. Our US GDP forecast is below consensus, at 1.9% this year. The acceleration of the slowdown in the housing market – a reliable harbinger of the overall economy – and the slope of the yield curve suggest the economy is not as strong as the US administration believes. 

Digging into the data, it appears that fear of higher interest rates is one of US households’ main concerns. Although it has not yet had a visible impact on consumption – consumer confidence is at a high point – it will negatively affect retail sales and credit flows sooner or later. We are already starting to see weak spots, such as the drop in restaurant sales since last summer, that indicate the US consumer is not in such good shape as it may seem. Bearish signs for the US economy are accumulating and will eventually push the Federal Reserve to pause monetary policy for at least Q1 2019 and even longer if the global economic momentum, led by China, does not improve. 

Australia in the crosshairs
Australia’s credit impulse is still in contraction, at -1.9% of GDP, and has been since Q3 2016. The country offset the global financial crisis faster than any other DM country by accumulating public and household debt at a fast pace and because credit contraction was smaller than in the US and followed a period of stronger credit expansion, with the credit impulse reaching a high of 6.8% of GDP before the crisis. 

But debt-fuelled growth cannot last forever, and it’s now time for the payback. 2019 will be a year full of dangers for the Australian economy as it will face the repercussions of China’s slowdown, and it will probably have to deal with more restrictive lending conditions following the recommendations of the royal commission’s report (due on February 1, 2019), which could add price pressure in the country’s property binge. 

In many cities, such as Sydney and Melbourne, mortgage repayments are above the risk zone (30% of average earnings). Any acceleration in the fall of real estate prices could put many Australian households in trouble, forcing the Reserve Bank of Australia to step in to prop up prices, eventually through quantitative easing. 

Japan heading for a slowdown

Japan’s credit impulse has been in negative territory since the end of 2017, and it is just now slightly back in expansion phase, at only 0.07% of GDP. This drop followed a two-year period of strong credit growth that started in 2016 and that helped to support the economy, through private investment and consumption, until now. 

Over the past years, in the context of a strong yen, Japan became less dependent on foreign demand, which should help mitigate the impact of the US-led trade war in the future. But now that the flow of new credit is drying up, we should expect lower growth in 2019 and 2020. Growth deceleration will also be furthered by the planned October 2019 consumer tax hike. But, like with previous hikes, the risk to growth is likely to be ephemeral and mostly noticeable in the third quarter of 2019. Last, but not least, there is not much to expect from the Bank of Japan this year as it should stay on hold since reflation is nowhere in sight.