Global economic outlook: clouds in the rear- view mirror, storm on the horizon?
Economic Quarterly Report
- 2016 started with chaos on the stock markets and the financial markets
- Recent economic data may look weaker, but is certainly not dramatic
- Persistent market turbulence could itself become a drag on economic growth
- There is no simple and accessible alternative to further monetary easing
Tumultuous start of the year
The financial markets got off to a turbulent start in 2016. The first two months of the year were characterised by sharp fluctuations of exchange rates, stock markets and oil prices, as well as by concerns about the economic outlook (of especially China), and more recently about the resilience of the banking system in the face of low interest rates and a low growth environment.
The recent sharp market declines need to be seen in the context of the rallies posted in early 2015, especially in Europe, which were driven mainly by the announcement and implementation of additional monetary easing measures by the ECB. At the same time, markets have become increasingly aware that extremely accommodative monetary policy is making less and less of a contribution to economic recovery, and also entails serious side-effects.
As economists, our main concern is the extent to which the current financial panic could hurt the economic outlook. If the turbulence persists, the markets could enforce their view through their effect on economic sentiment and financial conditions. The market is always proven right, even when it is not right …
Possible trigger number 1: The Chinese slowdown
The Chinese stock and currency markets had a rocky start of the year and the government’s poor communication and U-turns in policy response aggravated the situation. However, we maintain our view that the developments on the financial markets overstate the headwinds the Chinese economy is facing and underestimate its resilience. Recent data confirm China’s transition from an economy driven by heavy industry and investment to an economy driven more by consumption and services. Moreover, China’s external position remains particularly strong given (i) a sizeable current account surplus, (ii) still significant foreign currency reserves, and (iii) a net asset investment position (foreign assets exceed foreign liabilities).
Nonetheless, there are some risks to financial stability. First, leverage has been increasing at a pace far above economic activity, which seems to negatively affect marginal returns on investment and to depress economic growth. Second, the recent U-turns in government policy raise doubts as to whether the Chinese government is capable to manage the above-mentioned economic transition in an orderly fashion (in other words, to avoid a hard landing). Developments in China affect the rest of the world. Firstly, the slowdown in industry is likely to structurally temper demand for metals and energy, which will have serious consequences for commodity producers. Secondly, further depreciation of the yuan, transitory or not, is likely to erode the purchasing power of Chinese households. Countries with high level of exports to China are vulnerable to this.
Possible trigger number 2: Downward revision of the global growth outlook
In its World Economic Outlook (WEO) of January 2016, the IMF has once again revised its forecast for global economic growth downwards. This is partly due to the slower growth in China, but also due to the difficulties that emerging markets in general are experiencing. Low commodity prices (a disaster for commodity exporters in particular), the prospect of further monetary easing in the eurozone (which is weakening the euro and making products from emerging countries more expensive) and policy normalisation in the US (although this will be slower and milder than many people originally expected) are putting emerging markets under pressure. This pressure is manifesting in the form of weaker currencies and capital outflows.
However, the fact that emerging markets are highly dependent on commodity exports and vulnerable to the external environment are factors that have been recognised for some considerable time (see for example our view on Latin-America and Africa). Furthermore, the IMF’s adjustment of its growth forecast for global GDP is not that large. The fund is now forecasting economic growth of 3.4% and 3.6% respectively for 2016 and 2017 compared to its previous estimate of 3.6% and 3.8%, a downward adjustment of only 0.2%. More important, the forecast revision of the IMF is simply an alignment to existing market expectations, as also illustrated by the estimates we published at the end of 2015.
But the developments in the real economy in Europe and the US are less of a concern than the market panic and concerns about China suggest. We expect GDP growth of 1¼% and 2% for the Eurozone and the US respectively in 2016.
Possible trigger number 3: The oil price plunge in 2016
Oil prices have taken a further dive in 2016, with Brent crude falling below USD 30 per barrel for the first time since February 2004. This drop has been largely attributed to concerns about global economic growth, since disappointing growth can dampen demand for oil. However, this explanation completely ignores the fact that demand for oil in 2015 was 5% higher than predicted by the International Energy Agency (IEA) in early 2015 and was 2% higher than demand in 2014. Demand for oil is expected to increase further in 2016. Consequently, the currently low level of oil prices is mainly explained by factors on the supply side of the market. The huge supply of shale oil from the US and increasing supply from Russia and OPEC are such factors. Driven by such developments, annual supply increased by 2.7% in 2015. The increase in supply has so far turned out to be more resilient than expected, but the significant reduction in investment in the energy sector is also bringing the end of the so called ‘pork cycle’ closer. Therefore, we expect the oil prices to see some recovery over time, but to remain relatively cheap this year at an average price of USD 40 per barrel. On balance, lower oil prices are positive for the global economy, although they could cause socio-political and economic problems in producing countries. From a global perspective, low oil prices are a stimulus for household purchasing power, since the net oil importers account for 80% of global GDP. Low prices also have negative side-effects though, as they can exacerbate the risk of low or negative inflation expectations, which in turn may deter investment, hinder deleveraging and encourage a longer period of expansionary monetary policy. Low oil prices also undermine the business case for sustainable energy.
The bigger picture: dependencies require policy coordination
The ultimate underlying cause of the market panic seems to be the lack of global policy coordination and the resulting lack of confidence that current economic problems can be addressed through (monetary) policy. Moreover, the number of issues that are interrelated and require a coordinated approach is increasing. Figure 3 outlines the bigger picture, although this by itself also does not explain the timing of the panic.
Concerns about China and the downward pressure on the yuan as a result of declining foreign currency reserves are limiting policy flexibility of the US central bank. Fed chair Yellen recently stated that China was her greatest cause of concern and that could lead to (possibly indefinite) postponement of her intended rate hikes.
The combination of concerns about China and US Fed statements leaves little room for the euro to remain relatively weak. Given the still very vulnerable situation in many member states, the eurozone economy cannot afford either higher interest rates or a stronger euro. Assuming all other things remain equal, the best possible response of the ECB would be to consider additional monetary easing measures. The pressure coming from Japan will remain high, as Prime Minister Abe’s three-pillar programme is based solely on monetary easing and a weak yen.
Monetary coordination between the large central banks is therefore needed in order to break the line of least resistance. In this case, the line of least resistance is that of further monetary easing with diminishing marginal economic returns and more negative side-effects. Unfortunately, other issues are making such coordination difficult.
The economic and therefore also political rise of China entails a review of the global relationship between the US and China. China is increasing its presence in the South China Sea, through the incorporation of the Asian Infrastructure Investment Bank (AIIB) and the New Silk Road initiative. Therefore, the success of the Trans-Pacific Partnership (TPP) is more than an economic gain for the US: it actually represents a way of keeping increasing Chinese influence in the region in check and safeguarding US interests. The realisation of trade links with Europe through the Transatlantic Trade and Investment Partnership (TTIP) – which could lead to global standards for regulation and food security – can also be seen as more than an economic partnership.
The turbulence in the Middle East is another many-headed monster. The ending of economic sanctions against Iran is increasing tensions with its main rival in the region, Saudi Arabia. This is also increasing the downward pressure on oil prices, since both countries want to defend their market share and the tensions are standing in the way of a coordinated reduction of supply. Unless other producers follow suit, the oil production freeze agreed between Saudi Arabia and Russia in February will have little effect on the oil price, also because it merely fixes production at recently achieved peak levels. These tensions are also an obstacle to finding a solution to the conflict in Syria, de facto a proxy war between regional and international powers, with Russia on the side of Iran and against Saudi Arabia and Turkey/Europe. Given recent tensions between Turkey and Russia, as well as between Turkey and the US, and the possibility of ground intervention by either Turkey or Saudi Arabia, we are concerned that the situation could get further out of hand.
For Europe, the flow of refugees from the Middle East is a risk. This is paralysing decision-making in Europe and further fanning anti-Europe sentiment in the member states, with potential implications for the outcome of the Brexit referendum and for the free movement of people, which could mark the first steps towards European disintegration. This is hindering proper reflection and decision-making with respect to policy measures that could break the present European malaise and the global stalemate.
The Economic Quarterly is a publication of Economic Research of Rabobank and a co-production with Financial Markets Research.
The views presented in this publication are based on data from sources we consider to be reliable. Among others, these include Macrobond. The economic growth forecasts are generated from the NiGEM global econometric structure models.
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Abbreviations for sources: CBS: Statistics Netherlands, ONS: Office of National Statistics, OECD: Organisation for Economic Co-operation and Development, CPB: Economic Policy Analysis, IMF: International Monetary Fund.
Abbreviations used for countries: VK: Great Britain (UK), IE: Ireland, US: United States, DE: Germany, IT: Italy, NL: Netherlands, ES: Spain, AT: Austria, FR: France, GR: Greece, BE: Belgium, FI: Finland, EZ: Euro zone, PT: Portugal.
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