After a run of bad news, we are seeing more signs that growth trends are re- synchronizing among the major economies. Markets have responded in kind, with help from more policy stimulus around the world.
The widely anticipated acceleration in US economic growth seems not completely abandoned, just postponed. Following a stunningly weak second-quarter US GDP report, most economic reports point to a significant improvement over the summer. In Japan, the announcement of a massive fiscal stimulus program may not lift the mediocre growth rate right away, but it should boost business and consumer confidence and start adding to GDP growth in the fall. Meanwhile, business sentiment in China has improved to the highest level in a year and a half, highlighting the durability of its recent growth rebound.
Only the eurozone doesn’t fit the bill. The same surveys that track China’s improvement point to a modest European slowdown in the months ahead. Part of that is Brexit, but the bigger issue is its shaky banking system.
Financial markets get a sentiment boost
Global equities posted solid gains last month, led by strong performance in Europe (rebounding from the June Brexit selloff) and Japan (in anticipation of more policy stimulus). Fixed income markets also made a good showing: Government bond yields declined marginally, but corporate bond spreads rallied, contributing to the overall gains. Not surprisingly, the US dollar lost some ground against the major developed world currencies in the initial phase of the risk-on market rally. But it also weakened vis-a-vis emerging market currencies, particularly the South African rand and the Korean won.
The Fed lays low in the US
The weak second-quarter US GDP report has all but shut the door on further Federal Reserve rate hikes in the US this year. And a downgrade in future policy rate expectations at the next Federal Open Market Committee (FOMC) meeting in September looks likely. In June, the median of the FOMC members’ policy rate forecasts showed expectations of two more rate hikes this year. But that meeting also revealed how little conviction the Fed has in forecasts – both its own and the market’s. So, while most members may still be leaning toward raising rates further, we suspect the Fed will wait for stronger growth and, more importantly, evidence that it’s sustainable before acting again.
That is especially likely as long as inflation remains below target. With only three more meetings on the calendar this year and an increasingly contentious US presidential election campaign ahead, staying on the sidelines seems the best risk management strategy for the Fed. That alone should further support risk assets, as will the coming cuts in future policy rates.
The UK joins Europe with more QE
While the European Central Bank (ECB) has not announced any additional easing measures since March, some programs were only just implemented. The €20 billion increase in the bank’s quantitative easing (QE) program added corporate bonds to the list of eligible assets, the purchase of which started in June. This has already significantly compressed eurozone corporate spreads, indicating another noticeable easing in financial conditions. Adding to that, July saw the first auction of the ECB’s latest Targeted Long-Term Refinancing Operation (TLTRO) program, which is designed to ease the pass-through from easier financial conditions to more bank lending.
Almost immediately after the Brexit vote, the Bank of England (BOE) hinted at rate cuts over the summer. This came as no surprise to central bank watchers, but something else did: The BOE restarted its asset purchase program and included corporate bonds for the first time and, similar to the ECB, also announced a lending scheme. That won’t be enough to offset a sharp slowdown in the UK in the second half of 2016, but it should contribute to the easing of global financial conditions and may help avoid an outright recession.
Japan makes a fiscal push
Japan’s government announced a new massive fiscal stimulus program designed to boost aggregate demand– something monetary policy has failed to achieve in the past few years. At ¥28 trillion, or nearly 6% of GDP, it’s the biggest package since 2009. However, only ¥7.5 trillion represents new government expenditures that will directly contribute to GDP in the next two years, suggesting growth forecasts will only rise by 0.5% this year and 0.75% next year. The rest is harder to score and is likely to have a much smaller multiplier effect on the economy. Still, on the margin, the package will provide a much- needed stimulus to pull Japan away
from the recession danger zone. And, if combined with more monetary policy easing in the next few months, the impact could be stronger.
China picks up the pace
China’s growth surprise in the second half and its apparent sustainability through the summer quarter also has a lot to do with more policy stimulus. The underlying trend in aggregate social financing (the proxy for credit supply) started to re-accelerate last summer. While it started slowly, the pace picked up in November, indicating another round of monetary policy stimulus.
The government has also increased outright fiscal spending, indicated by a significant increase in the budget deficit to boost growth. Finally, the nearly 7% depreciation in China’s yuan since last August is starting to affect export revenues. Measured in US dollars, exports were still down 4.8% from a year ago in June, whereas local currency denominated exports values increased 1.3%. The combined effect of monetary, fiscal, and currency stimulus should keep the quarterly GDP growth trend between 6.5% and 7% for the rest of the year.
We are still optimistic
It was a dissonant first half of 2016 for global GDP growth. The US experienced disappointingly weak economic activity in all six months. The eurozone and Japan
surprised with stronger-than-expected growth in the first three months, but reverted to a weaker trend in the spring. It was the opposite in China, where growth in the first three months of the year slowed to the weakest pace in more than six years, only to rebound strongly in the second quarter.
After some excessive macro volatility, the second half of the year could deliver a more harmonious performance. China and the US are leading the growth acceleration, and more monetary and fiscal policy support in Japan and Europe should contribute to an easing of global financial conditions.
Yes, a few risks remain: Europe’s latest banking crisis hasn’t been resolved, a key constitutional referendum in Italy could trigger new elections, and the US will decide who will be its next president. But we think the year is likely to end on a more positive note, setting the stage for a stronger 2017.
Markus Schomer is managing director and chief economist at PineBridge Investments.
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