Global slowdown is set to affect the eurozone

Global growth is projected to slow down further in the next few months, affecting Greece and the rest of the eurozone, warn analysts at Pimco, one of the world’s leading investment funds.

In an analysis shared with Kathimerini English Edition, Pimco advises investors to be cautious for the time being, until the situation becomes clearer, as some rates markets are already taking recession-like conditions for granted.

Against a backdrop of political and market volatility Pimco analysts have concluded that the global economy is about to enter a low-growth “window of weakness.” They expect it to persist into 2020, with heightened uncertainty about whether it will be a window to recovery or recession.

During that window, they argue, “it would be prudent to focus on capital preservation, to be relatively light in taking top-down macro risk in portfolios, to be cautious on corporate and equities, to wait for more clarity and to take advantage of opportunities as they present themselves.”

In this context Greece has significantly improved its status of late: “Greece has been in a process of healing from the economic depression experienced in recent years,” Pimco analyst Nicola Mai tells Kathimerini English Edition: “The growth outlook has improved, capital controls have been lifted, and the government is running a sizable primary surplus. Uncertainty about the medium term outlook remain, suggesting that Greece is not out of the woods, but things are definitely looking brighter in the near term.”

This has seen Greek bond yields slide considerably, but the country’s junk credit rating prevents its benchmark rates from rivaling its peers in this global “window of weakness”: “The issue from an investment perspective is that government spreads (at around 200 basis points over Germany’s Bunds and 50bps over Italy’s in the 10-year space) are relatively unattractive, also considering the bonds’ illiquidity,” says Mai.

Pimco is significantly expanding its exposure in Greece as it has agreed to acquire a majority stake in Eurobank’s subsidiary Financial Planning Services (FPS), a licensed loan and credit management company, as well as a couple of nonperforming exposure packages from the same bank.

Its expansion into Greece is a sign of its growing confidence in the local economy. However, the overall picture calls for caution.

“In our baseline scenario, we expect global GDP growth to slow further over the next several quarters as ongoing trade tensions and heightened political uncertainty in multiple jurisdictions continue to act as a drag on global trade, manufacturing activity, and business investment,” Pimco, which manages funds totaling an estimated $1.7 trillion, says in its September 2019 Cyclical Outlook report.

“While labor markets have remained firm and consumer spending relatively solid in most advanced economies, we see the slump in global trade and manufacturing increasingly affecting other economic sectors via sagging corporate profits, reduced hiring, and a pullback in business investment.

“We expect US GDP growth to slow to a meager 1 percent or so in the first half of 2020, down significantly from 3 percent in the first quarter and 2 percent in the second quarter of 2019. This would further corroborate our thesis that US economic growth will be ‘synching lower’ toward the rest of the world over the course of this year. As a consequence, we see the global and the US economy entering a low-growth window of weakness during which they are more vulnerable than usual to adverse shocks, with heightened uncertainty about whether it is a window to recovery or recession. While a recession is not our base case, it doesn’t take much to tip over an economy that is moving along at stall speed,” the report warns.

“In looking at the investment implications of the cyclical window of weakness for the global economy, we note global rates markets price in recession-like conditions already, while corporate credit markets and risk markets more generally appear to price in better outcomes, either in terms of the macro outlook, the efficacy of central banks in continuing to suppress volatility, or both,” say the Pimco analysts.

“In this environment we think it prudent to focus on capital preservation and to be relatively light on top-down macro risk positions in our portfolios, combined with a cautious approach on corporate credit. Given the uncertainty in the outlook we will wait for more clarity and will take advantage of opportunities as they present themselves, rather than placing a great deal of weight on our baseline outlook in our portfolio construction,” the report adds.

On the eurozone in particular, Pimco sees it carrying on as a 1 percent growth, 1 percent inflation economy, despite the uncertainty. “Ongoing trade tensions will exert a significant drag on eurozone growth, somewhat offset by supportive domestic conditions, including easy financial conditions, some modest fiscal stimulus and some remaining pent-up demand. Sequentially, growth is expected to improve modestly over the forecast horizon as trade conditions improve gradually through the year, but this remains uncertain.”

“We expect core eurozone inflation to remain low, close to the current level of around 1 percent. It could rise by a tenth or two over the cyclical horizon in response to rising wages, but weak growth suggests that margin pressure for businesses will remain in place, limiting the pass-through of higher labor costs into prices. At the margin, the weaker euro exchange rate should provide a modest lift to core goods prices. While the European Central Bank potentially will cut the policy rate a little further, we would expect the focus to remain on forward guidance, targeted longer-term refinancing operations (TLTROs) and continued asset purchases,” conclude the Pimco economists.

Doubts also persist on the outcome of Britain’s effort to leave the European Union: “We expect an orderly form of Brexit over the cyclical horizon, either through an amended withdrawal agreement or a relatively orderly no-deal exit with side deals or stand-still arrangements in place, mitigating the short-run economic disruption. However, neither a chaotic no-deal nor a revocation of Brexit can be entirely ruled out, so while we have a stable baseline, we are mindful of left and right tail risks of outcomes worse or better than the central baseline,” Pimco analysts say.

“Brexit uncertainty is having some impact on eurozone growth. And a chaotic no-deal Brexit would likely shave a few tenths off eurozone growth in the near term. Having said that, Brexit is a much bigger issue for the UK than it is for the eurozone given the relative sizes of these economies, as nearly 50 percent of UK exports go to Europe, while only 10-15 percent of eurozone exports go to the UK,” Mai tells Kathimerini.