Economic Analysis - Rising Risks Of A Global Recession

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Glo bal

Eco no mic Activity

A g lobal reces s ion in 2016 is a clear and ris ing ris k. Althoug h our real GDP g rowth forecas ts do not differ g reatly from cons ens us for mos t countries , we are
larg ely more neg ative on g rowth on the whole, and es timate a hig her probability of a g lobal reces s ion s cenario this year than cons ens us . In this report, we
look at various troubled s pots of the g lobal economy which could be particularly vulnerable in the event of a g lobal reces s ion, or could thems elves trig g er a
g lobal economic downturn. While g lobal reces s ion is not our core s cenario, the conditions for a reces s ion are arg uably in place, and downs ide trig g ers are
not difficult to identify. In particular, a deterioration in China's economy is a very plaus ible s cenario, and would by its elf drag the g lobal economy down with it.
Growth To Be Weak In 2016
To beg in with, even our bas e cas e for g lobal economic activity in 2016 is lacklus tre. We project 2.8% real GDP g rowth (on a USD-weig hted bas is ), which we
have jus t revis ed down from 3.0% previous ly. This would mark the fth cons ecutive year of s ub-3.0% g rowth, and g iven that we forecas t long -term g lobal
g rowth of between 3.3-3.5%, output has been well below potential for a very long period. Larg e parts of the g lobal economy are in reces s ion or coming
clos e to it, including major emerg ing markets Brazil and Rus s ia, and we could even arg ue that emerg ing markets entered reces s ion in 2015, depending on
one's denition of reces s ion. While a real GDP contraction in 2016 is very unlikely on a g lobal level, this does not preclude reces s ion. The traditional
denition of reces s ion on a national level tends to be two cons ecutive quarters of real GDP contraction, but this has only happened once on a g lobal level in
the pas t 30 years (in the g lobal nancial cris is , when g lobal GDP fell by 1.6% in 2009), and we would arg ue that there have been epis odes that could be
qualitatively des cribed as reces s ionary where g rowth was weak but pos itive. We dene a g lobal reces s ion as below 2.0% real GDP g rowth at USD-weig hted
exchang e rates , which s ince 1990 has occurred in 1991 and 1993, 2001 and 2002, and 2008 and 2009. Each of thos e years can reas onably be des cribed as
'reces s ionary' for the g lobal economy, even thoug h real GDP g rowth averag ed 1.1% in thos e years . There are als o s ome other common characteris tics that
define g lobal reces s ions , s uch as as s et price corrections and trade weaknes s , which we identify below as 'potential s ig ns of reces s ion'.

Mind The Gap

Real GDP Growth And Long -Term Es timates (%)

Weighted by USD nominal GDP. Source: BMI

With emerg ing markets repres enting a larg er s hare of the g lobal economy with each pas s ing year, arg uably the thres hold for the g rowth level that denes a
g lobal reces s ion keeps ris ing , becaus e EMs g row more quickly on ag g reg ate than developed markets and rarely if ever contract (in 2009, EM GDP g rew by
2.7%, with EM ex-China ris ing by 0.2%). That being s aid, in 2015-16, emerg ing markets will pos t their wors t two-year real GDP g rowth averag e s ince 2001-02,
and in 2016, developed market g rowth will decelerate for the firs t time s ince 2012 (the heig ht of the eurozone cris is ). And if we exclude China, whos e headline
real GDP g rowth g ures we cons ider to be dubious , emerg ing markets will g row jus t 2.6% on averag e in 2015-16, well below potential of 4.5% and wors e
than the 3.7% pos ted in the g lobal financial cris is between 2008-10.
Potential Signs Of Recession
With s uch a weak g rowth outlook already part of our bas eline s cenario, we are watching s everal indicators that that could portend a g lobal reces s ion:
Global trade and output indices are not quite flas hing red jus t yet but look weak. Indus trial production is s lowing but s till g rowing on a year-on-year
bas is , and trade has flattened out and has s tarted to contract. Some key bellwether countries including Taiwan, Sing apore, Japan and South Korea have
all s een flat-to-contracting indus trial output in recent months . We note that neither indicator contracted in s ome epis odes that could have been
cons idered reces s ionary, particularly for emerg ing markets , s uch as 1997-98. With momentum s lowing in both trade and indus try, contraction may not

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be far off.

World Industrial Activity Cooling

Global Real GDP And Indus trial Production

Note: IMF quarterly GDP figures are purchasing power parity based, so figure does not align with BMI's annual
real GDP figures which are based on USD GDP. Source: IMF, CPB, BMI

Financial and liquidity conditions are deteriorating . Emerg ing markets ' international res erves are falling along s ide capital flig ht, weaknes s in commodity
prices , and faltering world trade. With China ag g res s ively s elling off its holding s , the decline in overall EM FX res erves has hit an unprecedented pace in
abs olute terms in the pas t 12 months . It is als o a s ig nificant revers al of the trend for EM countries which s aw domes tic monetary expans ion along s ide
res erve purchas es , which means that all els e being equal, res erve s ales are tig htening domes tic financial conditions .

Shrinking Reserve Pile

Emerg ing Markets - International Res erves

Source: IMF, Macrobond, BMI

The credit cycle has beg un to turn in emerg ing markets following a mas s ive leverag e bing e over the pas t decade, according to our commercial banking
indus try forecas ts . Meanwhile, credit g rowth in the US and Europe is only s howing 'g reen s hoots ' rather than s trong expans ion, and could be knocked
off cours e in the event of a g lobal s hock. Overall, g lobal g rowth in private s ector credit has beg un to contract (as of Q215), which is what we s aw in the
cris es of 1997-98, 2000-01, and 2008-09.

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Credit Cycle Turning Over

Emerg ing Market Credit-to-GDP (%) (LHS) and Global Credit To Private Sector % chg y-o-y (RHS)

RHS chart derived from USD totals. Source: BiS, BMI

As s et prices have further to correct, which is a clas s ic reces s ion phenomenon. We als o think equities have further to fall, with valuations s till looking rich
and earning s remaining under pres s ure (see 'Key Market Views Amid Global Recession Concerns', 28 January 2016). Sig nificant as s et price falls often s ig nal
weaknes s in the underlying g lobal economy. Emerg ing market equities have been falling for the pas t few years , while developed market s tocks may jus t
have beg un their des cent. The corporate bond market als o looks vulnerable, both in the hig h-yield and inves tment g rade s paces . Earning s are rolling
over, and even once-untouchable market leaders are feeling the brunt of a weakening g lobal environment (anecdotal evidence is mounting : Apple CEO
Tim Cook noted on January 26 that his company is s eeing 'extreme conditions unlike anything we've experienced before jus t about everywhere we look').

Ripe For Correction

MSCI All-Country World Equity Index

Source: Bloomberg, BMI

US monetary conditions may have already tig htened more than is widely appreciated. While the focus on g lobal monetary tig htening has revolved
around the US Federal Res erve's decis ion to hike by 25bps in December 2015, the Wu-Xia Shadow Federal Funds Rate has s hot up over the pas t 12
months at the fas tes t rate s ince the early 1990s (reflecting not s imply the token December rate hike, but als o the tapering of quantitative eas ing ). Each
time that this rate has increas ed by more than 1.5pp in 12 months , it has marked an inflection point in bank lending in the US, and in the world as a whole.
This is likely to play out ag ain at a time when g lobal economic activity already appears to be decelerating .

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Aggressive Tightening Already

US - Federal Funds Rate and Wu-Xia Shadow Fed Funds Rate Es timate, %

Source: Federal Reserve Bank of Atlanta Wu-Xia Shadow Rate Estimate, BMI

The drop in commodity prices has been s tres s ful for exporters but could prove to be a benefit to the g lobal economy as a whole over time, particularly
as the oil price collaps e repres ents a multi-trillion dollar redis tribution from producers to cons umers . Commodity producers look es pecially vulnerable
g iven that we do not expect a s ig nificant rebound in the broad commodity complex (see 'China And Commodity Risks: Australia, Chile, Brazil, Peru Stand Out',
28 January 2016) - and this extends to both emerg ing markets as well as key developed markets that are near to, or have jus t experienced, reces s ion
(including Canada, New Z ealand, and Aus tralia). And his torically, larg e falls in oil prices have preceded expans ions , not contractions , in g lobal activity.
Ag ains t expectations , thoug h, the vaunted 'oil dividend' for the g lobal economy has yet to really materialis e in the underlying data, with s tres s es in the
energ y s ector and a decline in the circulation of oil exporters ' petrodollars offs etting improved cons umer confidence and hig her dis pos able income in
cons uming countries . Becaus e oil's drop is a s upply-led decline in our view (rather than a collaps e in demand), it s hould be a pos itive factor. But the
s peed of the des cent is fomenting chaos in financial markets , g enerating mas s ive policy uncertainty (central banks of oil importing countries are uns ure
how to deal with the s econd-round effects , for ins tance), and hurting one of the few brig ht areas of g lobal capex of the pas t few years . It is not s o much
the long -term impact of low oil prices that worries us , far from it - but rather the potential for the oil s hock to create a broader economic and financial
s hock.
Many Potential Triggers
With conditions looking weak, there are s everal thing s that could trig g er a broader g lobal reces s ion.
The mos t obvious and arg uably hig hes t-impact caus e would be a s ig nicant further deterioration in Chines e economic activity. Our core s cenario entails an
increas ing ly s teep downturn over the cours e of the next two years but a pick-up in activity thereafter (see 'On The Brink: Five Scenarios For Growth', 3 February
2016). In one plaus ible downs ide s cenario, the Chines e authorities are caug ht between defending the yuan ag ains t increas ing ly acute depreciatory
pres s ures and providing ample liquidity to an increas ing ly tig ht credit market. Efforts to prop up the yuan take their toll on ons hore liquidity (in a s imilar
manner to that s een in the offs hore market in early January), s ending interbank rates s oaring and g iving ris e to an unplanned credit crunch which trig g ers a
los s in condence in banks , as well as in hig hly-leverag ed corporates . This prompts capital ig ht and a further tig htening of domes tic conditions , at a time
when g rowth is already s lowing and as s et prices are declining . Over time, the s overeig n balance s heet expands to abs orb bad debts and bail out
s ys temically important companies and local g overnments , but only s electively. By that point, thoug h, the damag e is already done, and economic output particularly in the cas e of xed inves tment - s lows cons iderably. This s cenario beg ins playing out in mid-2016, with Chines e real GDP g rowth falling from
around 6.0% at pres ent to 2.0-3.0% in the s econd half of 2016 and into 2017, before recovering to 4.0% in 2018.

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Yuan Going Lower

China - Exchang e Rate, CNY/USD

Source: Bloomberg, BMI

Trans mis s ion to the res t of the world from this would take place via s everal channels . Emerg ing market currencies would be s queezed as the yuan weakens
and the US dollar s treng thens . Commodity prices and g lobal ination would fall even further as Chines e demand declines , and uncertainty over the Chines e
outlook and its impact on the world economy would dent g lobal xed inves tment. Global trade would s uffer, taking the heavies t toll on As ian countries that
are clos ely linked to China in the s upply chain, and on commodity exporters . Als o importantly, the g lobal recovery would be s lower than the one in 2008-09,
which was boos ted by mas s ive policy expans ion from China. The fix would not be s o s imple this time.
A US reces s ion, even a modes t one, would not jus t knock out a major pillar of g lobal g rowth but would s hatter condence. For the US, the ques tion of
'decoupling ' from the res t of the g lobal economy, which was a common theory in 2008-09, has re-emerg ed. The main theory is that we are in a 1997-98 s tyle
s ituation in which the US's robus t domes tic g rowth can keep the country ins ulated from a meltdown in emerg ing markets . We are more circums pect on US
domes tic s treng th (see 'Don't Discount A US Recession In 2016', 7 January 2016) and are below cons ens us on 2016 g rowth, at 2.2%, but even if that were not the
cas e, the US looks more vulnerable to g lobal weaknes s than it did in 1997-98, from opennes s to international trade, to corporate prots . We note that there
were a lot of US reces s ion calls amid the 1997-98 As ia/Rus s ia cris is that turned out to be fals e, thoug h at that point the US GDP was g rowing above 4.0%
with undeniably s trong momentum, and that extra cus hion vers us g rowth of around 2.0% now is meaning ful. One of our core views is that the US dollar tops
out in 2016, but if it were to s pike hig her (for example in the event of a yuan devaluation), it would caus e further s tres s es acros s the g lobal economy and
could tip the US further toward reces s ion.
There are als o the 'hidden ris ks ' in nancial markets that could materialis e in the manner of Long -Term Capital Manag ement in 1998 or Lehman Brothers in
2008. This time around, for ins tance, a major commodity company (either a producer or trader) could collaps e, trig g ering further nancial tig htening and
broader defaults . Indeed, an emerg ing market corporate debt cris is is one of our 'hidden ris ks ' for 2016 (see 'EM Corporate Debt A Hidden Risk In 2016', 18
December 2015).

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