Economic and financial risk insights

Group Economic Research & Strategy, 10 September 2019

“No Indian summer for the global economy with winter having arrived in some parts already. Germany likely to be the first
country falling into a shallow but likely more protracted recession amongst G7 countries."
Key Takeaways:
• Recession fears are growing
amid a further slowdown and
we expect Germany to be the
first G7 country to fall into a
technical recession.
• We lower forecasts for
growth in the Eurozone and
the UK.
• Amid a sharp repricing in the
bond markets and continued
significant downside risks, we
downgrade forecasts of 10-
year treasury yield for the
US, EU and China this year
and the next.
• We now also expect three
more US Fed rate cuts to
come by January.
Jérôme Haegeli, Group Chief Economist
Risk landscape: What’s new?
• Recession fears rising globally: Global growth continues to slow, and the
manufacturing contraction across many regions has spread to the US. Forward-
looking business investment indicators more broadly are also worrisome. For now,
the services segment remains more resilient, so key to watch is any contagion from
the weakness in manufacturing. Regionally, 50% of the EU economies, still including
the UK, are contracting in Q2. We have lowered our growth forecasts for the EU and
UK, for 2020 and 2019/20, respectively. Among the G7, we expect Germany to be
the first to fall into a technical recession; risks of a broader downturn are rising. We
continue to see a 35% risk of a US recession in 2020. In China, the risk of hard
landing remains at 15% amid several supportive policy measures.
• Trade tensions continue to present the #1 risk to growth: The trade war
between US and China continues to escalate. Although some new US tariffs on
China announced on August 1 and effective September 1 were delayed until
December 15, retaliation by China and a further 5% ramp-up on all current and
announced US tariff levels have added to growth concerns. Negotiators appear to
have agreed to re-start talks in October, but in our view, a significant deal prior to the
US 2020 election remains unlikely.
• Brextention vs deal: The latest developments in the UK point to another delay to
Brexit. This follows UK Parliament legislation requiring the Government to request an
extension if an agreement is not reached with the EU by 19th October. We expect
the EU27 to agree to the UK's request to avoid a 'no deal' exit on 31st October and a
snap election in the UK later this autumn.

• Watch our monthly outlook • Other geopolitical risks percolate and add to downside risks: In Italy, there has
video been a change of government, though Prime Minister Conte has kept his post in the
new coalition. In Hong Kong, protests are ongoing despite the withdrawal of the
extradition bill that precipitated the unrest. Relations between Japan and South
Korea continue to worsen.
• We have cut our interest rate forecasts to below consensus. The bond markets
repriced sharply in August, with the long-term US Treasury yields close to all-time
lows. We have accordingly lowered our yield forecasts across most countries and
regions. We also foresee three further US Fed rate cuts by January, and still expect
the ECB to embark on renewed round of quantitative easing later this month, in
The balance of risks is addition to a rate cut and tiering.
negative in the medium term
Baseline view
A growth slowdown is underway, with manufacturing in a downturn. In light of significant
Negative Positive and persistent downside risks, bond markets repriced sharply in August. We have revised
Risk of no-deal our interest rate forecasts down again and to below market consensus.
Brexit
Dovish monetary
movement Key forecasts (in %)
Trade war
Real GDP growth Inflation CB policy rate 10y yield
escalates further
Fiscal stimulus in 2019 2020 2019 2020 2019 2020 2019 2020
Europe and China US 2.3 1.6 1.8 2.3 1.63 1.38 1.40 1.40
Manufacturing in Euro Area 1.1 0.9 1.2 1.2 0.00 0.00 -0.60 -0.60
recession
China 6.2 6.1 2.5 2.6 2.30 2.15 2.90 2.70
Source: Swiss Re Institute

For questions and comments, please email

Institute@swissre.com

Group Economic Research & Strategy – Swiss Re Institute 10 September 2019 1

Economic and financial risk insights

Global risk monitor

Probability
Risk Scenario Explanation & Trend
Both the front end of the yield curve and 10y-2y have inverted, economic momentum
is declining on the back of fading fiscal stimulus and the trade conflict is flaring up

US recession
again. Although key historical recession triggers are not flashing red, the risk of the US
economy entering recession in 2020 is relatively elevated at 35%.
35% 
Key to watch: Financial conditions, yield curve, trade negotiations, leading indicators
US-China tensions have escalated further since early August. While the EU may be
willing to settle disputes with the US, the tensions between Japan and South Korea
have intensified. A broader global tariff escalation remains a key risk.

Trade war
Key to watch: US-China trade talks, implementation of announced US-China tariffs in
35% 
Oct/Dec; Trump's decision on the auto sector national security implications report
(Nov); ratification process for USMCA; Japan-Korea trade tension

Monetary policy normalisation has largely made a U-turn toward further easing,
reducing but not eliminating the risk of a policy error that would lead to an excessive

CB policy error
tightening of financial conditions. Longer-term risks associated with prolonged
monetary expansion remain.
20%
=
Key to watch: 17-18 Sep: Fed meeting, 19 Sep: BoE meeting, 12 Sep: ECB meeting

Several conflict areas within the EU remain, including migration policy, national
budgets and the rule of law. Most notably, Brexit-related uncertainty remains elevated.
Elsewhere, tensions around Italy's budget may rise again, which could spark market
Destabilisation of
turmoil. Meanwhile, recent appointments (ECB, Commission, EP) point to policy
continuity in the institutions.
20% =
the EU/Euro area
Key to watch: Italian budget discussions, Brexit developments

Inflation has remained sluggish despite low or decreasing unemployment, accelerating

wage growth, and strength in the services segment. With central banks back in easing

Inflation risks
mode, inflation could increase to above target levels. Slowing growth, however, should 15%
dampen the risk. Inflation risk is higher in the US compared to Europe and China. =
Key to watch: Oil prices;12 Sep: US CPI; 18 Sep: Eurozone HICP; 27 Sep: US PCE

The risk of a debt-driven hard-landing of the Chinese economy has stabilised as a

result of earlier strong government efforts to deleverage the corporate sector and
better manage shadow banking activities. The US-China trade escalation has raised
Chinese hard
landing
concerns over another round of debt-fuelled stimulus. Further monetary easing is
expected to be limited taking into consideration rising inflationary pressure.
15%
=
Key to watch: US-China trade talks and other dispute issues, current account deficit,
renminbi depreciation, 10-year US-China yield spread

Many emerging market central banks are shifting towards easing-bias. More room for
easing measures lowers growth risks for emerging markets. In an adverse scenario,
Emerging market
contagion
external financing dries up and an investor panic could lead to an indiscriminate
withdrawal of funds from EMs.
10%
=
Key to watch: Sudden USD strengthening, higher DM sovereign bond yields

Stronger growth (than baseline) could come from a faster decline in unemployment /
stronger wage growth in the Euro area and the US, larger than expected fiscal
Stronger global stimulus in Europe and China, or a less damaging growth impact from Brexit. 5%
=
growth Key to watch: Strong credit impulse, Brexit negotiations, real interest rates

Group Economic Research & Strategy – Swiss Re Institute 10 September 2019 2

 Economic and financial risk insights

Regional forecast overview

US:
Amid a softer global backdrop and further trade US 2018 2019 2020 2018 2019 2020
escalation since the July rate move, we now expect Real GDP (% change) CPI (% change)
Swiss Re Institute 2.9 2.3 1.6 2.4 1.8 ↓ 2.3
the Fed to cut rates 3 more times by January and Consensus 2.3 1.9 1.8 2.1
foresee the 10-year yield coming in at 1.4% at IMF 2.3 1.9 2.0 2.7
year-end 2020. Meanwhile, our baseline US Fed Funds Rate (%) 10y Gov. Bond Yield (%)
growth outlook is unchanged from last month, at Swiss Re Institute 2.38 1.63 ↓ 1.38 ↓ 2.69 1.40 ↓ 1.40 ↓
2.3% yoy in 2019, slowing to 1.6% next year. Bloomberg Consensus 1.79 1.68 1.98 2.17

Euro area: Euro Area 2018 2019 2020 2018 2019 2020
Real GDP (% change) CPI (% change)
We have lowered our real GDP growth projections Swiss Re Institute 1.9 ↑ 1.1 0.9 ↓ 1.8 1.2 ↓ 1.2 ↓
for 2020 as prolonged manufacturing weakness Consensus 1.1 1.2 1.3 1.4
weighs on growth. Inflation and yield projections IMF 1.3 1.5 1.3 1.6

are also lower than last month. The German Refi. Rate (%) 10y Gov. Bond Yield (%)
economy has likely entered a technical recession Swiss Re Institute 0.00 0.00 0.00 0.24 -0.60 ↓ -0.60 ↓
Bloomberg Consensus 0.00 0.00 -0.33 -0.08
already and the risk of a broad-based decline in
economic activity is rising.

United Kingdom: UK 2018 2019 2020 2018 2019 2020

Real GDP (% change) CPI (% change)
We revised down GDP growth, and 10-year yield Swiss Re Institute 1.4 1.1 ↓ 1.0 ↓ 2.5 2.0 ↑ 2.0 ↑
forecasts, and revised up inflation. UK GDP Consensus 1.2 1.2 1.9 2.0
contracted more than expected in Q2 while IMF 1.2 1.4 1.8 2.0

activity remained weak going into Q3. At the same Bank Rate (%) 10y Gov. Bond Yield (%)
time, inflationary pressures have picked up, given Swiss Re Institute 0.75 0.75 0.75 1.28 0.50 ↓ 0.70 ↓
Bloomberg Consensus 0.75 0.80 0.77 1.11
strong wage growth and rising import prices.
Japan: Japan 2018 2019 2020 2018 2019 2020
Real GDP (% change) CPI (% change)
CPI forecasts lowered in 2020. The BoJ left policy Swiss Re Institute 0.8 1.0 ↑ 0.5 1.0 0.8 1.2
unchanged and remains the only major central Consensus 0.9 0.3 0.7 0.8
bank with an active QE policy. The upper-house IMF 1.0 0.5 1.1 1.5

election victory for the ruling LDP coalition fell short Overnight Call Rate (%) 10y Gov. Bond Yield (%)
of a 2/3 majority, meaning bold constitutional Swiss Re Institute -0.06 -0.06 -0.06 0.00 -0.25 ↓ 0.00 ↓
Bloomberg Consensus -0.10 0.00 -0.15 -0.03
changes will remain difficult for PM Abe.
China: China 2018 2019 2020 2018 2019 2020
Real GDP (% change) CPI (% change)
We revised up CPI forecasts while lowered 10- Swiss Re Institute 6.6 6.2 6.1 2.1 2.5 ↑ 2.6 ↑
year yield projections in 2019 and 2020. IMF 6.3 6.1 2.3 2.5
Manufacturing PMI remains contractionary at 49.5
Reverse Repurchase Rate 7d (%) 10y Gov. Bond Yield (%)
in August although other leading indicators (e.g. Swiss Re Institute 2.55 2.30 2.15 3.31 2.90 ↓ 2.70 ↓
OECD Composite leading indicator) are pointing to Bloomberg Consensus - - 2.97 2.88
some mild improvement. Given lowered
Note: Arrows signal up-/ downward revisions from last month.
corporates' loan rates along fiscal support, Chinese
economy is expected to stabilise.

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Group Economic Research & Strategy – Swiss Re Institute 10 September 2019 3

 Economic and financial risk insights

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Group Economic Research & Strategy – Swiss Re Institute 10 September 2019 4