Global economic outlook: Are we headed for another global recession? Sarah Hunter Head of Americas macro consulting

Global economic outlook: Are we headed for another global recession? Sarah Hunter Head of Americas macro consulting shunter@oxfordeconomics.com 10 th March 2016

Oxford Economics forecast highlights Baseline world GDP forecast for 2016 now seen at 2.3% slowest pace of global growth since 2009. Sell-off in global financial markets since start of 2016 a factor; overall financial conditions have tightened significantly since mid-2015. Also some signs of weakness in real economy broadening from industry/commodity sector to services. Currently expect US economy to grow around 2% this year, down from a 2.6% forecast in December. Other major economies have also been downgraded; Japan (to 0.8% from 1.2%), Eurozone (to 1.6% from 1.8%), Brazil (to -3.6% from -2.6%) and Russia (to -2.4% from -0.9%). Our concern is that the financial market slump could create negative credit and confidence shocks and negative wealth effects, which will slow growth further. 2

Stress signals are becoming louder... US: High yield bond spread % spread, high yield-aaa corporate bond yields 18 World 16 recessions 14 1.0000 0.9000 0.8000 12 10 8 6 Average spread in recessions High yield bond spread 0.7000 0.6000 0.5000 0.4000 0.3000 4 0.2000 2 0.1000 0 1985 1989 1993 1997 2001 2005 2009 2013 Source : Oxford Economics/Haver Analytics 0.0000 US: Credit standards and equity prices % quarter 20 10 Wilshire 5000 index (LHS) % -40-20 0 0-10 Q1 1996 Q1 2012 20-20 Q4 1998 40 3-30 Net % of banks tightening C&I loan standards (RHS, inverted) -40 1991 1994 1997 2000 2003 2006 2009 2012 2015 Source : Oxford Economics/Haver Analytics 60 80

and are starting to spill over to real activity World: PMI surveys Diffusion index, 50=neutral 65 60 55 US composite PMI World: Economic surprise indices % 60 40 20 G10 50 0 45 40 Global manufacturing PMI China Caixin manufacturing PMI -20-40 Emerging markets 35-60 30 1998 2000 2001 2003 2005 2006 2008 2010 2011 2013 2015 Source : Oxford Economics/Haver Analytics -80 2012 2013 2014 2015 2016 Source : Oxford Economics/Citigroup 4

with global growth forecast weakest since 2009 World: Industrial output and recessions % quarter 4 2 1 0.9 World: GDP % year 5 4 Long-term average Forecast 0-2 -4-6 -8-10 World recessions G7 industrial output 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 3 2 1 0-1 -12 1980 1985 1990 1995 2000 2005 2010 2015 Source : Oxford Economics/Haver Analytics 0-2 1981 1985 1989 1993 1997 2001 2005 2009 2013 2017 Source : Oxford Economics/Haver Analytics 2016 growth set to be the lowest since the recession year of 2009. Considerable downgrade since mid-2015 reflecting weaker incoming data and big financial market sell-off. Weakness in the world economy is still mostly centred in industry; manufacturing in the G7 is likely to be in a technical recession at the moment. And there have been tentative signs of softening activity in services too in January surveys e.g. in the US and Eurozone. Positive factors for services and consumption are low oil prices and still-solid property markets in most advanced economies but property markets have tended to move with stocks in recent years and there is weakness in some emerging and Asian property markets. 5

Overall picture amber alert We conclude that the situation is one of amber alert, not red alert High frequency economic data do not suggest recession but some financial market indicators are consistent with past recession periods All these indicators are fallible; the financial indicators tend to flag recessions around 50% of the time Current conditions are quite similar to 2011-12, a period of weakening world growth rather than recession World growth could edge down to 2% or even below this year, a very slow pace The last time this happened, we got QE3 from the Fed. Where is the circuit-breaker this time? 6 Current risk indicators and historical context Indicator Current Average 3 months Worst point in level before recessions recessions (av.) G7 Industrial output, qoq -0.5-0.2-2.3 World stocks, 6m chge -14-5.3-19 Real non-oil commodity prices, 6m chge -8.5 1.1-14 US high yield spread, % 7.3 5.4 8.9 US corporate credit standards, % 8.2 37.2 38.5 Source: Oxford Economics

What could the alternative look like? Financial fragility Chinese hard landing (15%) Housing sales slump sharply, triggering renewed house price falls and a sharp fall in housing construction. Domestic and external confidence is hit hard, resulting in lower FDI inflows, private investment and consumption The shock to growth spills over to emerging economies and sparks major currency realignment Geopolitical tensions (2%) A dramatic worsening in Saudi-Iranian relations triggers a violent reversal of recent oil price declines Crude oil prices rise back above $80 per barrel While the disruption is relatively short-lived, the global impact is material and varies hugely across countries Financial market contagion (10%) Amid signs of weakening growth, the current market gloom persists and weighs on global growth Equity price falls generate negative wealth effects, consumer and business confidence fade, and credit conditions tighten The Fed responds and reverses course; but some EMs are forced into rate hikes to defend their currencies Commodity demand weakness (10%) Oil prices fall further as global demand weakness weighs on commodity markets At current low oil prices, that drags modestly on global growth The boost to energy importers is outweighed by strains placed on exporter sovereigns and the US shale industry Emerging market commodity producers and the US are among those hit hardest Domestic demand fragility

US locomotive: A muffled whistle as we enter 2016 8

Service sector still holding up, but mfg contracting 9

Domestic fundamentals remain quite strong Jan 2016 151,000 231,000 222,000 10

Maturing labor market will mean smaller job gains 11

but wage growth should pick up the income baton 12

Housing continues gradual recovery Drivers: Income growth Low interest rates Modest home price inflation Pent-up demand 13

Headwinds from strong $ and weak global growth 14

IP technically in a recession, but not truly Only 26% of manufacturing sector contracting in December 2015 15

Fed to tighten at most 50bps this year 16

Eurozone: H2 weakness to extend into 2016 Eurozone Composite PMI & GDP Index 70 65 60 55 50 GDP (RHS) Composite PMI (LHS) % change q/q 2.0 1.5 1.0 0.5 0.0 Eurozone: Industrial production and manu. PMI Index 65 60 55 50 45 40 % 3-month on 3-month Manufacturing PMI (LHS) 6 Industrial production excluding construction (RHS) 4 2 0-2 -4 45-0.5 35-6 40 35 30 1999 2001 2003 2005 2007 2009 2011 2013 2015 Source : Oxford Economics/Haver Analytics/Markit -1.0-1.5-2.0 30-8 25-10 20-12 2006 2008 2010 2012 2014 2016 Source : Oxford Economics/Haver Analytics 17

Deposit rate to move deeper into negative territory The ECB look set to implement further monetary easing this month, as inflation expectations and forecasts drop back towards zero. We think that major changes to the QE programme are unlikely and that the main policy initiative will be a 20bp reduction in the deposit rate. Given concerns about the associated tax on banks, such a change may be augmented by a tiering of the deposit rate. Eurozone: CPI Inflation (Bottom-up f'cast model) % y/y / contr ibution 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0-0.5-1.0 Core Energy Food alcohol and tobacco Headline -1.5 2010 2011 2012 2013 2014 2015 2016 Source : Oxford Economics/Haver Analytics Forecast 18

Japan: GDP growth close to 1% pa in 16 and 17 19

Long-term rates turn negative 20

as stronger exchange rate hurts profits and exports 21

China: Real growth slowed more than data show Real GDP growth % y/y 16 14 GDP, Oxford Econmics estimate GDP, NBS 12 10 8 6 4 2003 2005 2007 2009 2011 2013 2015 Source: Oxford Economics, CEIC Data 22

Truly a two-track economy Real growth per sector % yoy 18 16 14 12 Primary Secondary Tertiary 10 8 6 4 2 0 2007 2009 2011 2013 2015 Source: Oxford Economics, CEIC Data Nominal growth per sector % yoy 30 25 Primary Secondary Tertiary 20 15 10 5 0 2007 2009 2011 2013 2015 Source: Oxford Economics, CEIC Data 23

...with excess capacity in industry still on the rise Production and capacity in industry 2007=100 Value added in industry 250 Production capacity in industry* 200 Excess capacity (RHS) 150 100 50 0 2001 2003 2005 2007 2009 2011 2013 2015 % 6 4 2 0-2 -4-6 -8-10 -12-14 Source: Oxford Economics, CEIC Data * From growth accounting 24

Financial leverage is rising Bank lending and total social financing % GDP 200 Total social financing 150 Bank loans 100 50 2003 2005 2007 2009 2011 2013 2015 Source: Oxford Economics, CEIC Data 25

and capital outflows have accelerated China: Financial capital flows US$bn 100 50 0 Composition net financial outflows (Q3 2015) Chinese outflows other than foreign lending 16% Repayment foreign loans 23% -50-100 Errors and omissions BOP -150 Foreign assets -200 Foreign liabilities Net financial flows -250 2007 2011 2015 Source : Oxford Economics, CEIC Data Foreign lending 31% Source: Oxford Economics, CEIC Data Repatriation foreign inflows 30% 26

Growth is expected to slow as economy rebalances 27

Commodity-dependent EMs continue to struggle 28

with Russia and Brazil in outright recessions BRICs: Manufacturing Purchasing Managers' Index Index, breakeven level=50 65 60 55 50 45 40 35 China Russia India Brazil 30 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Source : PMI/Markit/China NBS/Haver Analytics 29

Oil supply/demand balance not restored until 2017? 2013 2014 2015 2016 2017 2018 2019 2020 Global Demand 91.8 92.7 94.3 95.9 97.0 97.7 98.5 99.3 chg mb/d 1.2 0.9 1.6 1.6 1.0 0.8 0.8 0.7 Global Supply 91.3 93.7 96.3 96.5 96.8 97.4 98.2 99.0 chg mb/d 0.4 2.4 2.6 0.2 0.3 0.6 0.8 0.8 o/w OPEC 36.2 36.2 37.4 38.0 38.1 38.3 38.8 39.4-1.0 0.0 1.2 0.7 0.1 0.2 0.5 0.6 o/w US 11.7 13.5 14.5 14.2 14.2 14.4 14.5 14.6 1.2 1.8 1.0-0.3 0.1 0.2 0.1 0.1 Stock Build -0.6 0.9 2.0 0.6-0.2-0.4-0.4-0.3 Brent Oil Price 108.6 99.0 52.4 32.3 40.2 49.2 58.2 67.2 Source: Oxford Economics/ IEA 30

Global forecast summary 31 World GDP growth % change on previous year 2014 2015 2016 2017 2018 2019 Real GDP North America United States 2.4 2.4 2.0 2.5 2.4 2.1 Canada 2.5 1.1 1.2 2.2 2.6 2.6 Europe Eurozone 0.9 1.5 1.6 1.9 1.8 1.6 Germany 1.6 1.5 1.7 2.2 1.8 1.3 France 0.2 1.1 1.4 1.7 1.7 1.7 Italy -0.4 0.6 1.1 1.3 1.2 1.1 UK 2.9 2.2 2.2 2.5 2.2 2.2 EU27 1.4 1.8 1.9 2.1 1.9 1.8 Asia Japan -0.1 0.5 0.8 1.3 1.4 1.2 Emerging Asia, excl Japan 6.6 6.7 6.6 6.4 6.2 6.1 China 7.3 6.9 6.2 6.0 5.9 5.7 India 7.1 7.4 7.4 7.2 7.0 6.8 World 2.7 2.5 2.3 2.9 3.0 3.0 World 2005 PPPs 3.3 3.0 3.1 3.7 3.8 3.7 World trade 3.3 1.0 3.0 4.4 4.7 4.7

What could the alternative look like? Financial fragility Chinese hard landing (15%) Housing sales slump sharply, triggering renewed house price falls and a sharp fall in housing construction. Domestic and external confidence is hit hard, resulting in lower FDI inflows, private investment and consumption The shock to growth spills over to emerging economies and sparks major currency realignment Geopolitical tensions (2%) A dramatic worsening in Saudi-Iranian relations triggers a violent reversal of recent oil price declines Crude oil prices rise back above $80 per barrel While the disruption is relatively short-lived, the global impact is material and varies hugely across countries Financial market contagion (10%) Amid signs of weakening growth, the current market gloom persists and weighs on global growth Equity price falls generate negative wealth effects, consumer and business confidence fade, and credit conditions tighten The Fed responds and reverses course; but some EMs are forced into rate hikes to defend their currencies Commodity demand weakness (10%) Oil prices fall further as global demand weakness weighs on commodity markets At current low oil prices, that drags modestly on global growth The boost to energy importers is outweighed by strains placed on exporter sovereigns and the US shale industry Emerging market commodity producers and the US are among those hit hardest Domestic demand fragility

Alternative 1: China hard landing Domestic financial stress buildings in China, with banks non-performing loans rising, house prices dropping sharply and the equity market undergoing further falls. Investment collapses as credit dries up and demand for housing falls, and consumers cut back on their spending as a result of falling real incomes and weaker confidence. Outflows spike, as investors pull out of China. The authorities intervene to stabilise the currency, and allow it to depreciate by 10% relative to the USD. Other emerging market currencies also depreciate, while the JPY and EUR gain on a trade-weighted basis. 33

China hard landing: Impact on GDP 34

Alternative 2: Financial market contagion With real economic indicators showing signs of weakness, this scenario assumes that conditions worsen further in financial markets. Equity prices fall, particularly in the US where stocks remain overvalued, consumer and business confidence drops and credit conditions tighten globally. The US is hit hard, as the epicentre of the scenario. But contagion means that all countries experience a deterioration in financial conditions, particularly vulnerable EMs who experience a flight away from their assets. 35

Financial market contagion: Impact on GDP 36

Alternative 3: Commodity demand weakens further In this scenario demand for commodities weakens further, increasing the pressure in commodity-dependent economies. Emerging Markets such as Russia and Saudi Arabia are badly affected, and the impact is also felt in Australia, Canada and even the US, where the extraction sector sees sharp falls in equity prices and rises in corporate spreads. The impact on the rest of the world is limited. Growth is slowed by the downturn in the US and other commodity producers, but this is broadly offset by the positive boost provided by lower commodity prices. 37

Commodity demand weakens further: Impact on GDP 38

Thank you! Any questions? Sarah Hunter: shunter@oxfordeconomics.com