Combined growth of the main developed economies (U.S., Canada, Japan, Germany, France, Italy and the U.K.), known as the G7, has slowed sharply since the end of 2017. While this deceleration appears to have ended, and there is no evidence of a drift into recession, we do not expect a rapid bounce back in activity. Most likely, the G7 will see subpar growth for the next couple of quarters.
The Q2 GDP numbers, as foreshadowed by our G7 indicator (Figure 1), likely will be weak.
The source of the slowdown is easy to identify. The central banks of the U.S. and China tightened monetary policy in 2018. The U.S. Federal Reserve’s motivation was to normalize monetary policy and keep potential inflation in check, while the People’s Bank of China sought to reduce the growth of leverage. As economic conditions softened in early 2019, both institutions reversed their policies, which boosted equity markets. Since then however, businesses have started to cut back on investment because of uncertainty over how the U.S.-China trade dispute will play out. Combined with the current global decline in new car sales, this presents a serious and sustained headwind for the global economy.
On the plus side, inflationary pressures are minor and central banks have indicated that monetary stimulation is available. In addition, the major economies continue to add jobs, albeit at a slower rate than last year, and consumers remain confident. These factors lead us to believe that no recession is imminent.
Nevertheless, risk levels remain elevated despite the recent stock market recovery. Figure 2 shows the CBRE “real-time” China economy tracker. Following a sharp slowdown at the end of 2018 related to policy tightening, China’s economy picked up in the first half of 2019. More recently due to the U.S. trade conflict, there has been a renewed decline in activity. We do not think this will continue because of increasing levels of stimulus by the Chinese authorities, but this solution may not be quite as effective as it once was.
China and the emerging markets it drives make up 37% of the global economy. A soft patch for China is a soft patch for the global economy. Australia, which is strongly exposed to China, likely will see further rate cuts.
While the global economy is not drifting into recession, it is weak, particularly in the manufacturing sector, and vulnerable to further negative shocks. Monetary stimulus will help support activity, and the recent easing of trade tensions between the U.S. and China will also help. It is even possible that the current weakness has saved the global economy from a more serious slowdown in 2020 because it has stopped scheduled interest rates increases by the U.S. Federal Reserve.
On the other hand, a pickup in activity likely is not possible without a more substantial easing of trade tensions. Unemployment is unlikely to rise, but the rate of job growth will slacken further.
What does it mean for real estate?
Figure 1 shows that there have been two previous meaningful slowdowns in economic activity in this current cycle. The first was associated with the financial crisis in the Euro Area; the second with the fall in oil prices that undermined non-defense capital expenditures in the U.S. and elsewhere.
In general, real estate has performed extremely well over the period, with some ebbs and flows in activity. If we superimpose global office rent growth (Figure 3), we can see that a slowdown in economic activity is associated with a slowdown in rent growth.
Figure 4 shows changes in the global composite office yield. Interestingly in the last period of economic weakness in 2016, yield compression increased due to the fall in bond rates. We do not see further yield compression, but certainly the current fall in bond rates is supportive of cap rates so long as economic growth continues.
Our outlook is that capital value growth will ease for a while—perhaps even stall—but there will be no fall in values. Moreover, because of continued strength of the consumer economy, we don’t see a specific sector effect. If there is a downturn, it will be in the emerging markets and other economies that are linked to China.
By Richard Barkham, Global Chief Economist, CBRE.