US economy – the touchstone for the global recovery
Growth in the US economy should regain speed from the second quarter on, which will underpin the global economic upswing. In Europe, economic news flow is picking up rather more tentatively.
The US Federal Reserve’s exit strategy by tapering its quantitative easing is part and parcel of the process of normalisation that the growth and inflation regimes of the world’s premier economy are undergoing. In contrast, the European Central Bank (ECB) may well have to push through more measures yet to counter the risk posed by deflation. Lastly, the People’s Bank of China looks set to continue steering a stop/go monetary-policy course.
Now the harsh winter has melted away, the US economy is warming up again
The tempo of growth in the global economy is likely to pick up speed gradually, with the quickening pace of growth in the US set to be its locomotive force. Monthly data released so far point encouragingly to a distinct upswing in the US economy in Q2 2014, confirming our supposition that the loss of vim and vigour in the opening quarter this year could be blamed on the abnormally challenging winter weather. As such, we see no compelling reason to modify our scenario for the US economy this year, with GDP growth pitched at 2.7% to 3%. For now, relevant numbers are all showing inflation to be pretty mild.
As we commented in last month’s Perspectives, the Fed is likely to persevere with an endogenous monetary stance. Working on the grounds of its current tapering exit strategy, the Fed is likely to provide forward guidance to the markets on subsequent policy intentions. This seems unlikely to spring any real surprises on the markets though. The Fed’s QE tapering does imply both short-term rates and bond yields will be on course to revert towards normal settings, which has clear implications for investment policies with regard to bonds (see our ‘Strategy’ section).
Moving to the eurozone, leading indicators, such as Purchasing Managers’ Indices (PMIs), have been signalling economic growth perking up to around 2%, which looks a little overoptimistic. A rate of expansion along those lines would presuppose virtuous growth factors – the two most influential being exports and monetary conditions – becoming firmly embedded. On this score, nothing has been detected on the radar screen yet. The ECB might well be obliged to step up to the plate with some non-conventional monetary measures between June and October.
The latest numbers to emerge from China suggest economic growth has been levelling off at around 6.0%-6.5%. That said, the People’s Bank of China seems likely to have to continue pursuing a policy mix geared towards ensuring sustainable growth. Its preference is angled towards a stop/go approach, which can be equated to exogenous monetary policy, so as to keep a check on lending growth in the economy.
US: palpable acceleration in the economy in March and April
The US economy disappointed in the first quarter this year, with GDP growth practically flat. Consumer spending did rise quite vigorously, but that was negated by shrinking numbers being reported for most demand-side components.
The biggest surprise came in the shape of the ongoing contraction in public-sector spending. Government expenditure had already been dented by the temporary shutdown of the Federal Administration in early Q4 2013 so it had been expected to bounce back up in Q1 2014. Fortunately, the monthly pattern of growth makes much more cheering reading. The slowdown, chiefly connected to the unusually tough winter weather conditions, reached its trough in January. Most encouragingly, the overwhelming majority of monthly indicators have been heralding an energetic rebound in March/April. This is particularly the case for consumer spending, industrial output and employment. We are even tempted to argue growth might even temporarily race to over 4% in Q2 2014. Moreover, we remain upbeat about prospects for the second half when growth is likely to be running close to 3%.
At its Federal Open Market Committee (FOMC) meeting on 30 April, the Fed unsurprisingly announced it would further rein in the rate at which it has been buying assets under QE3 by another $10bn (to $45bn). The big swings in growth rates on the cards for these opening six months of 2014 should not exert any great influence on the Fed’s policy agenda. The tapering process should run on at the same tempo before coming to an end in October. We are still looking for the first hike in the Fed funds rate to come some time in mid-2015. That said, though, market expectations for future levels of short-term rates are probably pitched too low, in our view, and are likely to have to be raised in the coming months.
Eurozone: despite some upbeat survey findings, caution remains the watchword
The first sets of findings from economic and business surveys in Q2 2014 have hinted at eurozone growth quickening. The Markit Composite PMI climbed in April to 54.0, its highest level since May 2011, indicating the fastest rate of growth in activity for almost three years. A score like that would imply GDP growth in the eurozone of around 0.5% q-o-q in Q2 2014, a fraction higher than our own forecast for 0.4%. Nevertheless, in spite of this renewed optimism inspired by survey findings, we prefer still to err on the side of caution. The economic recovery remains both gentle and vulnerable as it is still heavily reliant on the dynamo of exports. The strong euro and all the uncertainty thrown up by the crisis in Ukraine are handicaps for exports. This brittleness has, moreover, been mirrored in some hard stats. The barometer measuring orders booked by German industry fell 2.8% m-o-m in March, its steepest drop since November 2012.
The slump can be blamed, to a large degree, on falling orders from abroad. In this setting, we are projecting GDP growth of 0.4% q-o-q for the eurozone in Q2 2014, followed by rates of 0.3% in each of the next two quarters, adding up to annual growth of 1.1% for 2014.
Developments on the prices front remain the main area of concern for investors. After the steep slide recorded by inflation numbers in March, partly due to the vagaries of the moveable Easter holiday, the rate bounced back up to 0.7% y-o-y in April. This rebound does not mask the fact that downward pressure on prices has not diminished (see the ‘Topic of the Month’ section starting on page 12). Inflation seems likely to remain subdued, hovering around 1%, throughout 2014, so well below the ECB’s medium-term target of 2% for price stability. Over the last few weeks, ECB spokespersons have been stating and restating the likelihood of non-conventional monetary measures being put in place aimed not just at revitalising growth, but also at forestalling the risk of deflation taking root. Despite those protestations, we do not believe any serious steps are likely to be taken before the autumn when the outcome of the stress testing is revealed.
China: economic growth seemingly stabilising
Growth in the Chinese economy slowed from 7.7% y-o-y in Q4 2013 to 7.4% in Q1 2014. Even though this rate of GDP expansion was a touch better than the consensus had been expecting, it was still the slowest quarterly rate recorded since the onset of the financial crisis. Annualised q-o-q GDP growth would appear to have decelerated to around 6.0%.
Monthly statistics released recently in China have been pointing towards the growth rate levelling out in April. The signals are still quite indistinct though, and the weakening trend on housing prices is giving rise to some concerns.
Nevertheless, steps taken to relax economic policy over the last couple of months should begin to filter through. Furthermore, fresh mini-measures targeted at stimulating the economy, along the lines of the recent cut in statutory reserve requirement ratios for rural banks, look on the cards for the not too distant future. This time around, initiatives may well be aimed more at exporters. We, therefore, persevere with our belief China’s economic growth will level off in Q2 with, just as in 2013, the tempo probably quickening again during the second half of the year. The acceleration is, however, likely to be little more than pedestrian.