Dr. Qian Wang
Chief Economist
Vanguard Asia-Pacific

What’s going on with China?

On March 1, U.S. tariffs on $200 billion of Chinese goods were set to increase to 25% from 10%. But with just a few days to go, President Trump indefinitely extended the deadline citing “substantial progress” toward reaching a trade deal.

China’s already feeling the pain of this trade war; its GDP slowed to 6.4% in the fourth quarter of 2018—the third consecutive decline. We expect China’s gross domestic product (GDP) growth to average about 6.1% this year. (It was 6.6% in 2018.)

China GDP growth

Forecast below consensus for first half of 2019

Bar chart showing Vanguard's forecast of China's year-over-year growth for 2019 is slightly below or equal to the market consensus.

Sources: Thomson Reuters Datastream, CEIC Data, Bloomberg, and the National Bureau of Statistics of China. 

How is China responding?

China’s growth derives from 2 economies:

  • An old economy based on state-owned enterprises—low-end and heavy manufacturing industries such as textile, coal, steel, and concrete production, as well as real estate.
  • A new consumer-driven economy led by private enterprises and reflected by domestic consumption, high-skill manufacturing, and service industries.

Our growth model shows that weakness in the new economy is primarily driving the current slowdown. To combat it, China needs to boost domestic sentiment and incentivize private enterprise. They’ve attempted to do that with a series of stimulus measures, which we believe will ultimately deliver. So we think an extreme slowdown, or hard landing, in 2019 is unlikely.

What’s this situation going to do to the markets?   

China has proven its ability to roil the global economy and financial markets. The relatively good news this time, however, is that China recently put capital controls in place that should lessen the risk of large-scale outflows and rapid currency depreciation.

In terms of economic growth, emerging markets countries will be hit hardest by the anticipated slowdown in China. The impacts are expected to be in the range of –0.10% to –0.20% for the United States but as high as –0.49% to –0.64% in Asian and Latin American emerging markets. Japan and Europe will also feel the sting from export-related weakness. 

So is there going to be a U.S.-China trade deal? 

The recent pause in escalation might persist while negotiations continue. A partial deal could involve a significant rise in China’s imports, easing restrictions for foreign firms and creating more equal tariff alignment. This should reduce the probability of a more significant slowdown in China this year.

However, the scope of U.S.-China disagreements extends beyond trade to areas like investment, technology, intellectual property rights, market access, and industry policy. Although China has expressed intentions to make fundamental structural reforms down the road, it will be challenging to meet the pace and magnitude of changes desired by the U.S. administration.

Therefore, the U.S. may use the pressure of further escalation to pursue a later deal on long-term issues. Chinese policymakers will remain on alert, ready to deliver additional stimulus measures if the situation turns sour.

 

Peter Westaway
Peter Westaway
Chief Economist
Vanguard Europe

What’s going on with the U.K.?

Britain’s narrowly won vote to leave the E.U. after 46 years of membership (“Brexit”) was mainly motivated by concerns about unrestricted immigration of E.U. citizens into the U.K., the relative lack of sovereignty over decision-making that E.U. membership entailed, and the ongoing financial cost of being a member. Given that it’s been over 2 years since the referendum, why is Brexit still so chaotic? The U.K. Parliament hasn’t yet been able to pass an exit plan the E.U. will also agree to.

At the moment, no political consensus has been reached on what rules should apply to the U.K.-E.U. relationship post-Brexit. One particular stumbling block is the treatment of the border between Northern Ireland and the Republic of Ireland, which will now form a land border between the U.K. and the E.U. Indeed, the inability to reach an agreement has increased the possibility that the March 29 deadline will be extended and even that a new referendum might be called, which could potentially reverse the original decision and lead to the U.K. staying in the E.U. after all.

What’s this situation going to do to the U.K. economy?

Most economists agree that the impact to the U.K. is likely to be negative, with GDP falling because of the less-advantageous terms on which the U.K. will be able to trade with its nearest neighbors. Imported goods and services will tend to be more expensive. There may also be long-term costs once the U.K. becomes relatively less open to the flow of people and ideas that can stimulate growth. So far, there’s some evidence that the uncertainty surrounding Brexit has caused firms and households to defer spending plans until the situation is clarified, while overall U.K. growth seems to have fallen behind peers in the G7 (the countries with the 7 largest advanced economies) over the last 2 years.

But looking forward, the seriousness of Brexit’s impact on the U.K. economy will depend on the terms of the eventual deal between the U.K. and the E.U.

Almost certainly, the worst outcome all around would be for the U.K. to leave the E.U. without any deal at all, though we believe this is relatively unlikely. “No deal” would be the hardest type of Brexit on offer, involving the U.K. moving on to World Trade Organization trading arrangements with higher tariffs and more restrictive movements on goods across borders, as well as the lapsing of other U.K.-E.U. arrangements.

We believe it’s more likely that some kind of deal with the E.U. will be reached, probably involving a type of free trade arrangement with the E.U., with minimal tariffs but no harmonization of standards as they’d have as part of the European Single Market. This would probably be costly for the U.K. economy and still constitute a moderately hard Brexit.

Less costly would be some variant of a so-called soft Brexit. This could be achieved by staying in the customs union with the E.U. or joining some variant of the European Economic Area (sometimes called the Norway option). Either of these options would have much less economic impact, but neither would realize many of the possible benefits of leaving the E.U., since the U.K. wouldn’t be able to curb E.U. immigration and would need to continue to pay into the E.U.

What about investors in the U.S.?

So far, the exchange rate has borne the brunt of Brexit uncertainty, falling around 10% since the 2017 referendum. U.K. equities have probably been slightly weaker than would have been expected, while U.K. fixed income has probably been more robust as the Bank of England policymakers have held off raising interest rates. If “no deal” is taken off the table, it seems likely the exchange rate would rally slightly—even more so if Brexit were reversed altogether. But the threat of a hard Brexit or even “no deal” still means there are downside risks to U.K. investments.

The bottom line: With so many options still on the table, we just can’t be sure what’s going to happen. In the absence of a crystal ball, the case for a well-balanced globally diversified portfolio of stocks and bonds is as strong today as ever.

Editor’s notes: This article was adapted from blog posts published on Vanguard’s institutional sites. Dr. Wang would like to thank Adam Schickling, CFA, a junior economist in Vanguard Investment Strategy Group, for his assistance with her post.

Notes:

All investing is subject to risk, including the possible loss of the money you invest.

Diversification does not ensure a profit or protect against a loss.

Foreign investing involves additional risks including currency fluctuations and political uncertainty.