A Broader Perspective on the Global Economy

April 25, 2016

A Broader Perspective on the Global Economy

  • Easing monetary policies go on globally but do not seem to fuel sustainable growth.
  • China is slowing, Japan is looking toward another recession, and the global outlook is adjusted downwards.
  • Bad news might be around the corner, but good news is as well.

Introduction

News is usually focused on the latest happenings. The fact that the human brain is set up in a way that it always tries to focus and eliminate marginal information brings to the consequence that most people do not objectively analyze the world around them. An example: How many blue cars have you seen today? Probably none because you were not looking for them, but as soon as you focus on them you will be surprised by how many you will see. The same applies to finance.

Just two and a half months ago the S&P 500 was 12.5% lower than now and headlines were filled with negative scenarios. Oil prices were below $30 and investors looked to avoid any kind of risk by selling stocks and buying bonds. Then, on February 11, FED Chairwoman Yellen hinted to Congress that “the central bank had increased trepidation over the path of interest-rate increases, pointing to accumulating risks to the economy in recent weeks.” The market focused on prolonged low interest rates and not on the accumulating risks in the economy. This article is going to give a broader perspective on the current state of the global economy in relation to financial markets by taking a look at the situation in the strongest economies.

The US

The main economic indicator, albeit one that shows only what has happened, is the Gross Domestic Product (GDP).

Figure 1: US GDP estimates and actual. Source: The Wall Street Journal – Economic Forecast.

The Wall Street Journal has surveyed 60 economists and their estimations are positive and project stable growth of more than 2%. As shown in the figure above, the previous estimates (red line) are usually stable and positive, while actual results (grey columns) are much more volatile and with negative surprises.

There is a rule in finance where if you are wrong with your estimation alongside others the collective wrongness saves you, but if you are wrong and your opinion is far from consensus, your career is at risk. Unfortunately, this usually brings stable, similar estimates close to each other and big actual surprises.

A more scientific way of estimating GDP is done by the Federal Reserve Bank of Atlanta with GDPNow, as it uses only econometrical models based on economic data variables. Figure 2 shows how this metric diverges from the general consensus above.

Figure 2: Atlanta FED GDPNow forecast. Source: Federal Reserve Bank of Atlanta – GDPNow.

The GDPnow model is forecasting only 0.3% growth for Q1 2016. The first advanced estimate from the Bureau of Economic Analysis (BEA) for the first quarter 2016 is due on the 28th of April and will show who is correct, in any case it could be market moving news.

Japan

Japan is still finding it tough to reach stable economic growth. “Abenomics,” the monetary easing policy implemented by Japan’s prime minister Shinzo Abe in 2012, is failing to produce the expected results. If Japan experiences another quarter without growth it will be just another recession that has plagued Japan’s economy in the last two decades.

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Figure 3: Japan’s GDP growth. Source: Trading Economics.

A recession in Japan should not make a big influence in international markets as it is generally expected that Japan stagnates, but both the incapacity of creating economic growth—even with a negative 0.1% interest rate—and the aging population strongly resembles the situation in Europe.

Europe

The Eurostat will publish preliminary flash estimates of quarterly GDP for the EU area on the 29th of April, synchronizing publications with the BEA (usually 15 days later). This is another piece of information that will be interesting for markets.

Estimates from the European Commission are that the EU area will grow by 1.9% in 2016, but the European Central Bank’s (ECB) decisions do not support such a positive forecast. Last week ECB president, Mario Draghi, left the current low interest rate and market purchases policy unchanged and hinted towards further easing in order to bring the EU economy to the expected levels. Almost two years of interest rates close to zero and the ECB purchasing even corporate bonds did not yet push the EU economy towards the hoped levels, an indication that strong growth for the EU might be difficult to reach. Also, Markit’s Composite Flash Purchasing Managers’ Index is showing signs of slowing growth, falling to 13 month lows in March 2016 for the EU.

Other political issues threaten European growth in 2016. The UK will vote on whether to remain in the EU in June and the pre vote polls do not indicate a clear winner. The UK leaving the EU would have significant economic repercussions and increase the political uncertainty that would strongly influence the Euro and the markets. The immigrant crisis from the Middle East is still a concern and possible increases in border controls might further slow economic trade.

Apart from the negative view, there is always hope that the easing policies will work, the weak Euro promotes exports, the UK might vote to stay in the EU, and immigration might help improve the negative demographics in Europe.

China and Emerging Markets

A fact that was soon forgotten is that the Chinese economic growth in the last few quarters was the slowest in the last 25 years.

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Figure 4: Chinese economic growth from 2010 to 2016. Source: Trading Economics.

China is still growing but many expectations and models that were based on higher growth rates have to be amended. The economic slowdown did induce the huge drop in commodity values in 2015 and that effect will surely reflect itself in local and global economic measures.

China sneezes and emerging markets get a cold. The largest economic downward adjustments are seen in emerging markets, of which Brazil and Russia are the most pronounced. The International Monetary Fund (IMF) expects that the prolonged slump in commodity prices will have a severe impact on emerging markets as they base their economies on exports of primary goods. Africa’s growth is expected to be around 3.7%, thus far from the usual high single digits.

Conclusion

A quick look at what is going on globally does not give much inspiration. The news did not change much since February except that central banks are going to continue with quantitative easing that gave relief to markets. But, the outlook is much bleaker than it was a year ago and the low commodity prices do not contribute to a global increase in economic activity. The IMF predicted in its February outlook that global growth in 2016 would be only 2.5%, which is 35% lower than the average of 3.8% for the last 6 years.

Even if the above data might be a little bit pessimistic, to brighten up the article, China, Africa, the US and Europe are all still growing, albeit at a slower pace so severe economic crises are not expected. But negative news may be just around the corner, so investors should be careful when assessing their risks.

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