With growth so slow around the world, it won't take much in the way of negative economic shocks to tip many economies into recession.
A Deutsche Bank AG team led by Chief Economist Peter Hooper sees a five-headed dragon that could weigh on global activity going forward: a rate hike from the Federal Reserve, a jump in energy prices, a fall in equities, a deceleration of Chinese growth, and a depreciation of the Chinese currency.
To this end, Hooper modeled how each one of these shocks would impact over two dozen economies two years following the event, as well as the effect on global GDP as a whole.
1. A Fed hike
A rate increase from the Fed would tend to reduce the size of the global economy by roughly 0.4 percent two years later, hitting the U.S. economy by a marginally larger amount.
The effect of a hike on the U.S. and global economies are similar to the findings of the Fed's model, says the Deutsche team. The economists also caution that results showing a Fed hike was associated with faster growth for an economy were not statistically significant.
"While the negative impact of Fed rate hikes on global GDP is noticeable and in some cases quite significant, this is not a reason to council the Fed to avoid raising rates," writes Hooper. "We recognize that if the Fed finds it is appropriate to tighten policy because it is meeting its objectives, delaying doing so could mean having to tighten more aggressively (with commensurately greater negative effect on the rest of the world) if inflation were to get out of hand as a result of that delay."
2. Oil prices spike
An increase in oil prices would tend to spur investment in some regions in the world, but tend to crimp consumption.
Surprisingly, Deutsche Bank's model holds that an increase in oil prices would be a modest tailwind for global activity.
The team notes that the counterintuitive potential impact of an increase in oil prices on China — an oil importer — in the above analysis skews the global picture. If the world's second largest economy were to be excluded from the equation, the conclusion would be that such a rise in oil prices would constitute a slight drag on global activity over the next 24 months.
"The source of the shock to oil prices – whether it is driven primarily by a shock to demand or supply – is critical to assessing the impact on global growth and that the size of the impact also depends importantly on the extent to which oil price fluctuations are passed through to end-user prices, such as retail gasoline prices," writes Hooper, noting that his model is unable to distinguish between the two.
3. A global selloff in stocks
A notable decline in global stocks is slightly worse for economic activity around the world than a Fed hike, according to Deutsche Bank's modeling.
A one-standard deviation decline in global equities equals a decline of 5.5 percent on a GDP-weighted basis.
Broadly, emerging market economies suffer more as a result of this shock than the global economy does, however, the BRICS nations included in the sample are some of the least afflicted/most immune from a downturn in equities.
Hooper's team notes that such declines in stocks are generally indicative of deteriorating risk sentiment, which can weigh on emerging market currencies and prompt a deceleration or reversal of capital inflows.
4. A slowdown in China
When China sneezes, emerging market economies closely tied to it will catch a cold.
"The economies that suffer the largest hit to growth from a China slowdown are generally small economies and/or are tightly connected with China (e.g., Singapore, Thailand) and commodity exporters (e.g., Saudi Arabia, Malaysia, Indonesia)," writes Hooper.
An interesting tidbit: the model suggests Australia, which exported an ever-increasing amount of raw materials to China in size during its growth miracle, largely shrugs off a deceleration in growth from the world's second largest economy. Deutsche Bank's team note that this result is indeed surprising, but say it jibes with other studies on the country-level effects of a Chinese slowdown.
5. Chinese currency depreciation
Last August, the market turmoil that resulted in the wake of China's surprising decision to devalue the yuan spurred fears of a global recession.
But a 10 percent depreciation in the Chinese yuan hurts the world less than half as much as a 1 percentage point deceleration in growth, Deutsche Bank's team found.
Separately, Hooper suggested there was also "some evidence of global disinflationary pressures from this shock," namely, a 25 basis point decline in the global prices two years later relative to where they would have been.