2016: weakest year since 2009
May 2016: weak growth and currency gyrations will push policy makers into action
Recent economic data has confirmed what we had already guessed: the global economy has been engulfed into a soft patch since the beginning of the year. Chinese and US GDP growth both weakened further, compared to the second half of 2015, and the modest acceleration of European growth, although good news for this region, wasn’t strong enough to compensate weaker demand elsewhere. Those who keep an eye on business cycles can’t help but notice that, over the past few years, the first half of the year has been weaker than the second and that, with time and revisions, these discrepancies have often been ironed out, particularly in the US. Therefore, a legitimate debate on the odd seasonality of growth numbers is going on. Yet, the current weakness of the global economy seems genuine. In the US, for instance, where growth slowed to 0.5% in Q1 (quarterly annualized rate, that is practically flat), exceptionally mild weather conditions seem to have flattered production and demand, implying that more normal conditions might have resulted into an outright contraction of output. Similarly global trade of manufactured products was almost flat in the first quarter, hammered by weak demand across the board, but even more from China, where the rebalancing of the economy is making incremental but limited progress, and from commodity exporters, where governments are coming to grips with the unpleasant reality of shrinking royalties by ordering cold turkey diets in their fiscal decisions.
On the monetary front, the main surprise was the passivity of the Bank of Japan. The sharp rise of the Japanese yen since mid-December is totally at odds with what the Abe-Kuroda team is desperately trying to deliver: stronger nominal GDP growth, thanks to a mix of productivity enhancing reforms and macro-reflation. Another cut of the deposit rate, which the BoJ has twisted so much that it shouldn’t hurt banks’ earnings, would have probably been instrumental in capping the currency, if not reversing its trend. Maxime Alimi, Laurent Clavel and Varun Ghotgalkar have drawn the market lesson of this failure to act: in the short term, the JPY may continue to rise and Japanese stocks to decline but, eventually, the government will be forced into action, using both its fiscal and monetary arms.
Even more important for the global economy is the future path of the Fed Funds Rates (FFR) decided by the Fed. Neither real data nor inflation measures –PCE inflation retreated to 0.8%Y and its core component to 1.6%-- are warranting a second rate hike in June or July, despite the FOMC’s prediction of two rate hikes this year. Only a significant acceleration of real and nominal data would allow the hawkish camp within the FOMC to convince the majority, starting with chairwoman Janet Yellen, to raise the FFR target to the 0.5% - 0.75% range before the elections.
Non-economic developments may also enter into economic policy equations. In this regard, we are closely tracking opinion polls and political debates in the UK. David Page’s constant view has been that, in the end, UK voters are more likely to opt for remaining in the EU, so large are the uncertainties surrounding a Brexit. Recent developments have supported his view). Yet, as we get closer to the polling day, the domestic debate will become ever more political and ever less focused on the ‘pure’ economic dimensions of EU membership, which implies that the result remains highly uncertain. Until June 26th, we should be ready for higher volatility in the FX market, but also in the UK equity market. And since a Brexit decision may have deeply disruptive consequences on continental European politics, continental markets may also turn more volatile, all the more so that the negotiation on the Greek bailout might be stretched until June –a familiar story- and that, in Spain, general elections seem to be in the offing too.
Paradoxically, markets may turn more receptive to the news flow from China, where authorities have made up their mind and started to resort to targeted fiscal stimulus in order to keep economic growth above the minimum necessary to keep the reform process on track. The sharp rise of credit events (private companies failing to meet their financial obligations in debt markets) so far this year, 16 default cases totaling RMB13.2 bn, surpassing the nine cases (involving 9.9bn) in the entire 2015, is a good omen. In this regard, given the large debt overhang China is suffering from, it is a sign of confidence that Chinese authorities are letting companies default, thus helping the market to better price domestic corporate credit risks. There is no other way to build the genuine, deep and liquid, onshore credit market alongside which Chinese companies need to fund their businesses with a so far very speculative equity market. Yet, just as authorities have been following a trial-and-error tactic when dealing with equity and FX gyrations, they may appear more interventionist if the shockwaves of some credit events look too destabilizing. Again, a recipe for higher volatility. The more fundamental question for China is: is it possible to deleverage the economy, at least the private sector, without causing unwanted economic drawbacks. Aidan Yao and Shirley Shen have investigated this thorny issue, looking at a broad range of deleveraging episodes in the world and drawing lessons for China. Their conclusion is cautiously optimistic: yes not-too-painful deleveraging is possible, depending on policy action, but is by no means warranted.
What’s new in the May 2016 Blue Book?
- Global growth slowed in Q4 / Q1, hurt by China and the US. G-4 GDP growth fell to 2.2% saar in Q4 and did not accelerate in early 2016. Yet, the US and China seem to be accelerating while €-area is facing stronger headwinds (poor business sentiment, strong euro)
- Worst year since 2009 for global GDP growth: 2.7% in our forecast, below downwardly revised IMF forecast (3.2%). Productivity growth is low (0.6% on trend in the US). Global demand < global supply, contributing to low-flation. Fiscal policies are unlikely to plug the gap, adding pressure on central banks. This will continue to squeeze profits and harm equities.
- The Fed has turned more dovish than expected. A June hike is less likely. Yet, the FOMC is deeply divided and hints of a stronger Q2 may give the upper hand to the hawkish camp.
- The Fed’s dovishness has weakened the US$ and given a shot in the arm to US stocks. Yet, growth divergences are likely to lift the $ again and equities are in a bear market.
- Crude oil: US shale peaking and production freezes have lifted quotes to $50/bbl. Risks tilted on the downside (Iran, inventories). A 60% price fall since 2014 should support global demand.
- China: Slowdown is under control. Weak dollar has helped China to follow its new FX policy book without causing larger capital outflows. The yuan TWI is down 7% since 08/10 2015.
- ECB’s bold action (QE raised to €80bn/month, extended to non-bank IG in June, new TLTROs) has crushed bond yields but failed to cap the euro. The ECB may have to turn more proactive.
- Despite the rise of the JPY, the BoJ has failed to act in April. A depo rate cut remains likely but also a more proactive fiscal policy, helped by monetary financing.
Also, those interested in long term themes such as aging and longevity might want to jump to pp. 75 and 76, to visualize the unstoppable rise of human longevity since 1840, and the highly linear link between the wealth of nations and life expectancy in good health. Food for thought…
There are also some important topical issues the Blue Book doesn’t deal with, but which the AXA IM Research team has investigated. From the rise of emerging Asian equity markets to the travails of Abenomics, here is our Research Vault.