World economy getting more and more out of sync
Cycles in the main economic blocs shifted further out of sync with each other over the summer months. The eurozone registered no growth whatever for the second quarter of the year and leading indicators are, moreover, pointing downwards. Conversely, the US economy is on course to generate self-sustaining growth of some 3%.
Against the backdrop of US and European economic cycles drifting ever further apart, monetary policies being pursued by the European Central Bank (ECB) and the US Federal Reserve have also been following quite different paths. In a drive to stimulate growth and counter deflationary risks, ECB President Mario Draghi is indeed moving from words to deeds as the ECB shifts towards instituting a number of programmes of quantitative easing (QE). Fed Chair Janet Yellen, however, seems to be steering the Fed on a course of exiting from its QE strategy, with the QE3 round on track to be wound up by late October.
Cycle desynchronisation – the upshot of the 3GDs
This dephasing of both economic and monetary policy cycles in the world’s main economic blocs, which we have referred to on several occasions in Perspectives, became even more pronounced this summer. In this respect, we would simply point out this can be traced to our ‘3GDs’, the acronym coined to describe the ‘Great Divergence’ in Europe, the ‘Great De-monetisation’ in the US, and the ‘Great Dynamics’ in the emerging world.
The ‘Great Divergence’ characterising eurozone economies refers to the divergent trajectories of economic growth, on the slide, and public debt/GDP ratios, on the climb. Recently released economic data reveal the eurozone economy has been slowing again quite noticeably, flat-lining with zero q-o-q growth in Q2 2014. Worse still, leading indicators are pointing downwards, with, for instance, the flash Purchasing Managers’ Index (PMI) for Manufacturing sinking to its lowest (50.8) since July 2013. In a move to kick-start growth and ward off deflationary risks, ECB President Mario Draghi has crossed the Rubicon, making the move from words – his famously defiant statement from July 2012 to “do whatever it takes to preserve the euro” – to action. The asset-purchase programme announced on 4 September will lead to the ECB’s balance sheet being expanded by around €1,000bn.
Moving to the US, the ‘Great De-monetisation’ refers to the Fed’s QE exit strategy which is being deployed simultaneously with US economic growth seemingly well on the way to slotting into a tempo of annualised self-sustaining GDP growth of around 3% for the coming 18 months. Lastly, the ‘Great Dynamics’ is the term we have used to describe the reality whereby most leading emerging nations are evolving from export-led economies to economies driven more by domestic demand, with the ensuing knock-on effect of a generalised slowing in rates of growth and a shift in monetary policy stance.
US: encouraging signs for growth in Q3 2014
After slipping into the red zone in Q1 2014, US GDP bounced back powerfully in Q2, registering annualised q-o-q growth of 4.2%. Even though July’s consumer spending data were a little on the disappointing side, most statistics released for July and August have been pointing in the direction of GDP growth in line with our expectations (+3.0%) in Q3 2014. As for the final quarter of this year and the first next year, the outlook is bright as well. Expanding employment and rising household income have been picking up speed, standards applied to the granting of loans have been softened somewhat, bank lending has been rising strongly, and businesses are seemingly more ready to invest. Given that state of affairs, our scenario is accordingly unchanged: GDP growth in the US should be pitched close to 3.0% in the second half of this year and into 2015.
Over the last few months, the pool of labour in reserve has been drying up quite quickly, but, for now, wage rises are still fairly modest. Moreover, after quickening between February and May this year, core inflation has levelled off again, with the rate on the Fed’s bellwether core personal consumer expenditure (PCE) deflator displaying a reading of 1.5% y-o-y. In these circumstances, we see no pressing reason to revise our scenario as regards monetary policy despite the slightly more heartening economic outlook or the arguably more hawkish tone of the Fed’s public statements. We stand by our expectation that the QE3 round of asset purchases will end in October, with the first hike in the Fed funds rate likely to happen around mid-2015 and that key rate set to close 2015 at around the 1.25%-mark. Futures markets do not, however, seem to have fully grasped and priced in that sort of scenario (Fed funds rate factored in at 0.7% for end-2015). Market expectations, therefore, look likely to have to be ratcheted up over the next few months.
Eurozone: spluttering German economy giving rise to concern
Recent macroeconomic news flow for the eurozone has been dispiriting. In the aftermath of Q2 2014 GDP growth already falling short of expectations (0.0% q-o-q), more recent statistics and leading indicators have been suggesting the risk of a further turn for the worse in Q3. After a mini-bounce in July, the composite PMI relapsed again in August, sinking to 52.5, its lowest level since the start of this year.
More alarmingly, Germany’s economy seems to be losing power. Its bout of weakness can be blamed, in part, on the geopolitical tension fuelled by the Ukraine/Russia crisis which appears to have hit manufacturing hard in the eurozone’s powerhouse economy. Although exports to Russia account for a mere 3% of Germany’s overall total, the indirect impact, especially as regards business decisions on whether to invest or not, is likely to be tangible. Findings from the August Ifo survey resulted in the Business Climate index sinking for the fourth month in a row to its lowest ebb (106.3) since July 2013. Germany’s weakness is compounded by struggling economies in Italy and France as they fail to reignite their growth-burners. For now, Spain alone is managing to keep its head well above water – it notched up its fastest rate of quarterly growth (+0.6% in Q2) since end-2007. In response to this litany of disappointing figures, we have downgraded our forecasts for eurozone growth. We are now projecting GDP growth of 0.2% q-o-q for the eurozone in Q3 2014, followed by rates of 0.3% in Q4, adding up to annual growth for 2014 of just 0.8%.
Adding to the woes is the fact that inflation has slumped to its lowest level since October 2009, registering a 0.3% y-o-y rate in August. Stagnation and looming deflation combined to crank up even more pressure on the ECB this summer. Following Mario Draghi’s headline-grabbing speech at the Jackson Hole summit, the ECB’s Governing Board has taken action rather earlier than expected, lowering benchmark rates by a further 10bp and launching a programme to buy asset-backed securities (ABSs) and covered bonds. As the economic recovery may well prove disappointing and inflation stay subdued, the prospect of sovereign debt being repurchased by the ECB cannot be ruled out as a possibility for 2015.
China: growth rebound still quite fragile
Economic news flow for China in recent months can be split into two stages. Initially, there were plenty of signs of a relatively energetic upturn in the economy: steep rebound in PMIs and GDP growth for Q2 2014 coming in comfort- ably ahead of expectations at 7.5% y-o-y. Economic statis- tics released more recently, though, have been less heartening, in particular lending flows, well down in July, and PMIs, dipping back down in August.
This suggests the recovery is still pretty vulnerable, with concerns focused primarily on the housing sector. Sales of residential housing, measured in terms of floor space, have been falling, prices are starting to slide, and the stock of unsold property is mounting. For the time being, the string of mini-measures designed to soften economic policy, coupled with improving export growth, have been helping to cushion the negative impact flowing from this dip in the housing sector. This should continue to be the case in the near future, especially as further pro-economy measures are likely to be pushed through by Beijing. Despite that, the risks are still running high. Although we are still confident about prospects for the second half of this year, the picture for 2015 is looking cloudier. At this juncture, though, we see no reason to modify our current projections for annual GDP growth averaging 7.3% this year and 7.0% in 2015.