The Decisive | Season 3 Ep.4 - Global Macroeconomic Insights: The US and Mainland China

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Ken Wattrett:

Hello, everybody. I'm Ken Wattrett, Vice President of Global Economics at S&P Global Market Intelligence. Let me begin by introducing Ben Herzon, our Co Head of US Economics, and Yating Xu, our Principal China economist.

Yesterday was, of course, Inauguration Day for the new US President and the various changes in policy which could be implemented by the incoming administration have the capacity to make a material difference to the economic outlook. Our assumptions for those policy changes and their expected economic implications will be the key theme.

In our December forecast round, various changes to our assumptions on US tariffs and labor market conditions and the likely consequences of those led to three key changes. First, we revise upwards our estimates for US and global consumer price inflation. Second, we assumed less accommodative global financial conditions going forward than we previously been forecasting. And 3rd, related to the first two points, we made downward revisions to our growth forecasts for most of the major economies we cover for this year and next. Our base case remains 1 of continued global economic expansion, but we continue to expect slowdowns in the world's two biggest economies, the US and China, which we'll look at very shortly.

And between them, they account for over 40% of global GDP. We lowered our global real GDP growth forecasts for this year and next to around 2 1/2% in December, below our estimate for 20/24 of 2.7% and significantly below 3% plus growth rates globally that were apparent in the years leading up to the COVID-19 pandemic. Now, of course, the uncertainty surrounding all our forecasts has risen materially given the uncertain policy outlook. So let's start with that and let's take a closer look at some of our key national assumptions and forecasts, beginning with the US.

Can you please tell us more about our key policy assumptions under the newest under the new administration in the US and the expected economic implications of those?

Ben Herzon:

Thanks, Ken. I'd be happy to. So let me start with the key assumptions. We have tax cuts, we have spending cuts, we have tariffs and we have restrictions on immigration and deportations. With regard to tax cuts, we assume that the personal tax provisions of the 2017 Tax Cuts and JOBS Act are extended indefinitely. That is, those tax cuts are permanent, remain permanent.

We do have some added tax relief on tip income and overtime pay. We do assume some relaxation of the cap on the state level tax deduction and we assume a lower corporate income tax rate for US corporations that produce domestically. We also have assumed some spending cuts in a forecast. With regard to tariffs, we assume an average effective of tariff rate on the university of 10%, so 10% average universal tariff with a 30% tariff on imports from mainland China. We assume that these tariffs are phased in over the course of a one year beginning at some point in the second quarter.

We do assume that that countries from around the world impose retaliatory tariffs on US exports going into their economies. With regards to immigration, we assume some crackdown on immigration. And the way the numbers pan out is that we assume that net international migration into the US is reduced by 500,000 per year during the course of the Trump presidency. Now with regard to the macroeconomic implications of these policies, well, tariffs are inflationary. Tariffs get passed on to domestic prices in our baseline forecast with a 10% universal tariff and 30% tariff on imports from mainland China, core PCE inflation rises to about 4%.

The restrictions on immigration and deportations will lead to labor shortages and faster wage inflation in directly affected industries. This will reinforce the inflation that results directly from tariffs. Rising rates of inflation will prompt the Fed to pause its easing cycle. So we assume just 50 basis points of Fed easing this year over the first half of this year, followed by a one-year pause. Now this pause in Fed policy puts upward pressure on Treasury yields and leads to tighter financial conditions generally. What I'm talking about is we have higher private borrowing costs in our forecast, a stronger dollar and weaker equity values.

Now this, the stronger dollar and retaliatory tariffs weaken US exports. The immigration restrictions in our forecast directly reduced consumer spending and housing demand. And all of these factors combined more than offset the boost that we expect to get from tax cuts and lead to a generally weaker outlook than we expected prior to the election.

Ken Wattrett:

Thank you, Ben. As I mentioned a short while ago, uncertainty over the outlook is obviously unusually high. In light of this, can you give us an idea of where you see the key risks to our base case?

Ben Herzon:

You mentioned it, the risks mainly stem from uncertainty about policy. So the tariffs that we assume in the forecast are roughly 1/2 the tariff rates that that President Trump had campaigned on. So tariffs could turn out to be more severe than we assume, or they could turn out to be less severe. We don't have a great sense for how much deportation the Trump administration intends or is even possible for that matter.

With regard with regard to tax policy, we're not sure that a closely divided Congress will even go along with the tax cuts that are proposed by President Trump if they're not paired but with appropriate spending cuts. So the risks to the forecast are both positive and negative. We believe that we have positioned our baseline assumptions to balance those risks. That is, we view the chances of more extreme policies then we assumed to be roughly equal to the chances of less extreme policies. More extreme policies, for example, higher tariffs than we assume, more deportations and stricter immigration policy than we assume would weaken the outlook relative to our baseline and less extreme policies.

That is, lower tariffs and an easier immigration policy would imply a stronger outlook than we assume. So the risks are on both sides and we view that our baseline assumptions essentially balance those risks.

Ken Wattrett:

So, we've talked for some time now about a growth slowdown in the US that's been evident but limited to date. What are the indicators which would signal more pronounced weakening in train?

Ben Herzon:

So growth has slowed just not as much as we expected about a year ago.

So just to put some numbers on it, average quarterly USGDP growth in 2023 was 3.2% per quarter. It did slow to a rate of 2.4% per quarter last year. That slowing was centered around interest-sensitive spending. So business fixed investment did slow. There's a lot of other factors that led to the slow down. Housing starts did weaken. But the reason that growth didn't slow as much as we expected was that consumer expenditures remained pretty robust. And this strength reflects what's been ongoing strengthened labor markets and continued rising equity values promoting pretty strong household wealth.

So going forward, the indicators that I will look for suggesting that growth will continue to slow will be indicators that suggest consumer spending would be about to slow. So what that means is I'll be looking at the job market. I'll be looking for some material slowing and job gains that would translate to weaker wage and salary income. I'll be looking for a weakening of equity values. Over the last month or so, equity values have kind of flattened out. I'll be looking to see if equity values turn lower. That would undermine household balance sheets and would contribute to a slowdown in consumer spending.

And I'll also be looking at measures of consumer confidence. If those erode sharply, that would be sort of the leading indicator of weakening consumer spending and, hence, a continuation of the slowdown that we have in our forecast.

Ken Wattrett:

Thank you, Ben. Let's move to China and bring in Yating. Building on what we've just heard about the US, what are we assuming for tariffs on China and are they the key reason for the recent reduction in our growth forecast?

Yating Xu:

Thanks, Ken. Yes, there are two factors, potential tariffs and persistent demand side weakness. We have seen that China has successfully met its annual growth target for 2024 at 5%, which aligns our expectations. Growth accelerated significantly to 5.4% in Q4. All subsectors from supply side accelerated, particularly the property sector. It ended the 6 consecutive quarters of contraction. The improvement was driven by like the consumption growth and front-loaded exports.

Though we expect the momentum to continue into like early 2025, saying the front-loaded exports and consumption and property recovery, it doesn't change our current view of the slowdown this year and next year as the tariff risks and demand side weakness remain. While the stimulus haven't been materialized yet, and there are still uncertainties around the scale and effectiveness of the policy, the key assumptions include the US increasing tariff rates on Chinese imports to 30% from current average level of around 20%; reduced export subsidies from China; and tariff reductions to other trade partners.

Also, we expect currency depreciation and exports redirection provide only limited relief. Again, stimulus will remain cautious due to like debt pressure, excess capacity concerns and also potential slower Fed easing. More specifically, we expect net exports to turn negative in 2025 with exports declining compared to a rapid growth in 2024. Industrial production will significantly slow from around 6% in 2024. It is notably higher than the 5% real GDP growth. In 2025, we expect it to slow to a level that is more close to GDP growth because manufacturing production will be adversely affected by weak exports.

Also external headwinds are projected to further undermine China's private sector confidence and a job market will present additional challenges to property sector and private investment. Also we expect growth engines to shift from exports to domestic demand this year due to increase in external challenges, although the measure stimulus efforts will only offer a cushion and not fully offset the negative impact.

Ken Wattrett:

Thanks, Yating. You mentioned another key growth headwind obviously, which has been the the difficulties in the property sector. What are we expecting for that sector going forward and its impact on the overall economic outlook?

Yating Xu:

Property construction and sales have declined by over 50% from their peaks in 2021 following three consecutive years of contractions.

It's close to Japan's real estate bubble bursting. I mean the scale of the decline, this indicates like there'll be limited to room for further decline. Also, China's low urbanization rates and high household saving rate suggests that demand has not vanished. But the thing is how long would it stay at the bottom. For the first time last year, the authorities have prioritized stabilizing the property sector within China's economic targets. We have observed some signs of improvement in housing sales markets since late 2024 and property returned to expansion in Q4 last year. The government also voted a series of stimulus to support the stabilization in the property sector.

Those measures if effectively implemented could foster sustained recovery in the property sector and support the bottom out of sales and maybe later translate into investment improvement. However, we expect that the property sector will continue to exert a drag on the economy through much of 2025, though with a milder drag compared to the previous years because we remain cautious about the effectiveness and the scale of these policies due to a combination of curbs including like debt pressure, government concerns and housing price rise and most importantly the economic reform targets shifting away from property and investment to manufacturing production. So in terms of the impact of property sector on the economy, there are four major channels which are like representing uncertainties in ongoing recovery.

First, the decline in investment. While government funding aimed at completing the finish the projects may ease the rest investment downturn, it will take time for the improvement in housing sales to translate into investment demand. More importantly, 3 consecutive years of declining in land purchases indicates that a near term rebound in property construction remains unlikely because they don't have enough land to build on over the short term.

Second is the persistent negative impact on industrial production. Industry such as like steel and glass that related to property sector will continue to face constraints until turning point in property investment.

And third channel is the services GDP reduced drags. We see reduced drags since properties the only negative sector of GDP in 2024. We expect that the drag will be smaller this year. But it is only a smaller drag to GDP growth, but unlikely to be a driver to GDP growth.

The fourth impact on the GDP is continued negative impact on private consumption. The housing-related consumption may like improve negative wealth effects will continue to weaken consumption confidence until housing price expectation recovers. I haven't seen clear signs of the housing price recovery so far.

So in summary, housing sector will continue to be a drag, but less drag compared to previous years. The latest time that we see recovery or a bottom-out will be the last quarter of 2025.

Ken Wattrett:

Now you mentioned that the authorities have been responding, you know, to these headwinds with additional policy support. Could we see a situation where additional stimulus changes the economic outlook? And if so, what form would that stimulus most likely take?

Yating Xu:

Sure. Developments of trade tensions and domestic policies are the two major risks to China's near-term forecasts.

There are both positive and negative risks around our forecast. The positive risk relates to like more aggressive than expected stimulus policy. The authorities have voted more active fiscal policy and moderately ease monetary policy. They use positive wording that we first seen since the global financial crisis. The policy details are expected to be announced in the two sessions in March this year. So if the stimulus package is aggressive enough, say in with sufficient scale and be effectively implemented to bolster consumption investment to mitigate the tariff drag, it could prevent the economy from a shock moderation.

But let's say how big should the stimulus be to compensate the potential tariff drag? From the fiscal side, we will look at whether the fiscal deficit ratio could increase to like 4% or above from 3% in 2024. Also, we'll see whether the ultra-long treasury bond could increase to CN¥2 trillion or above from the CN¥1 trillion in 2024. Also we may like follow that whether special purpose local government bond will be increased from less than four trillion, 3.9 trillion 2024. So that is the fiscal policy. And in terms of monetary policy, we'll see if the PBOC could aggressively cut the reserve requirement ratio by like 50 BPS or above or cuts interest rates by 30 BPS or more.

But also those increased stimulus scale should effectively be implemented. In other words, those increased borrowing should be effectively spent and those policy be effectively implemented to first compensate the consumer items tradings to promote private consumption. But the consumption-driven policy will still be constrained by weak job market and income outlook. Also, whether those borrowing will be used to compensate equipment upgrading program to boost a continued manufacturing investment growth. However, the excess capacity issue and already fast and large scale upgrading in 2024 may contain the ongoing effectiveness. The third, whether those money could be used to purchasing unsold housing to accelerate property sector destocking. This could be the most effective policy we like should follow.

But as we discussed previously, the government has been pushing property derisking for years. So a large scale property stimulus may not be the priority of the policy tools. Again, funding unfinished projects is a policy tool that's suggested by the government to support property investment and mitigate default risks. However, it is a bottom-line policy to prevent risks rather than driving the growth. And another policy that has been announced is the large government debt swaps to ease the government debt pressure. Again, it is a policy to prevent spread of the risks.

It strengthens local government spending ability but won't directly increase spending. There are other uncertainties around the effectiveness of the stimulus like the Fed policy progress, the excess capacity issues and also some fundamental issues like Asian population. So there is risk of upgrade of forecast if policy package is aggressive enough or tariffs are less than we expected, but there are a lot of uncertainties around it.

Ken Wattrett:

Indeed, there are, thanks, Yating. Thank you everybody. We've run out of time, so we need to bring the session to a close. Thank you to today's speakers. Thank you all for dialing in. Goodbye for now.