The global growth story – cause for concern, not panic
Tandem fall in equities and oil
Equities have tanked in the past fortnight. While the US Dow Jones is still up about 4.7% year-to-date, global equities are down 1-2%. Eurostoxx 50, emerging markets and the FTSE 100 are down about 1%, 7% and 8.5% respectively (in local currency terms). There are arguably multiple causes to the equity slump and greater volatility since mid-year, including the backdrop of global conflicts (Russia-Ukraine, Syria etc…). In the UK, very uncertain general elections in five months time have not helped either (as I discussed in Labour still ahead of Conservatives but UKIP is potential kingmaker).
Importantly, analysts are pointing to the tandem fall in oil prices, in itself not revolutionary as the correlation between oil and share prices has been quite strong in the past 4-5 years, as the clearest sign of weak underlying economic growth and mounting concerns about the growth outlook. The reasoning is that falling oil prices result from weak global energy demand and economic growth, rather than a supply shock or OPEC mis-management – a scenario also negative for equities.
Is that the case today? It may be irrelevant to an investor, at least near-term, whether markets are right or wrong to assess growth as weak and downgrade equity and oil prices. But if markets are wrong, they may eventually re-price the growth outlook and equities higher.
The bottom line, in my view, is that markets should be concerned about the underpinnings of growth in the eurozone and Japan and certainly Russia (and more generally the oil exporters) but less so about the US and somewhat more comfortable about the rest of Asia. Net-net, I see the risk tilted towards growth being modestly below the IMF’s forecasts, with the oil-importing EM economies with scope for reflation coming out best.
The irony is that, whether markets are right or not about growth, a sustained and pronounced fall in equity prices could in itself depress growth in the medium-term via weaker confidence, demand and investment – the beginnings of a self-fulfilling prophecy. But we are still quite a way from that scenario in my view.
Falling oil prices due to strong supply, not just weak demand
For starters, the International Energy Agency (IEA) takes a somewhat more nuanced view. The IEA, which accurately forecast falling oil prices in 2014, expects rising oil inventories in H1 2015 to put further downward pressure on prices (see Figures 1 and 2). It points to both oil over-supply, the result of years of high prices and capacity building, and a slowdown in the growth of global oil demand (see OMR, December 2014). It does not expect demand to pick up much due to:
- Weaker growth and demand in oil-exporting economies, including Russia;
- A strong US dollar, which increases the local-currency cost of oil imports;
- Government cutting oil subsidies;
- Consumers having shrunk consumption or become more energy efficient after years of high prices;
- Generally weaker global economic growth in the OECD, a tepid economic recovery, weak wage growth (a topic I touched on in UK’s solid economic metrics drowned out by EU and immigration debate) and – last but not least – worrying deflationary pressures.
So what about global economic growth?
The IMF’s October World Economic Outlook forecasts robust global GDP growth of 3.8% in 2015, in line with the 1996-2005 average and the fastest since 2011, and US growth at a decade high of 3.1% (see Figure 3). But while markets may not yet be panicking about the current growth rate, they may have genuine concerns about the major economies’ ability and willingness to loosen fiscal and monetary policies in the event of future shocks dampening growth.
US – concerns about timing and magnitude of monetary policy tightening probably overstated
Talk is not about whether Fed monetary policy will be loosened but when QE will be unwound and rates go up. The USD dollar appreciation – about 13% since May (in DXY terms) – is in itself a tightening of monetary policy, even if the US is not a particularly open economy, which may at the margin delay the need for further monetary tightening any time soon. In any case any tightening is likely to be gradual.
Eurozone – not much left in the policy tank
The scope for fiscal loosening is limited given that most eurozone (and EU) economies already run deficits near or above the implicit 3% of GDP target (see Figure 4). Calls for Germany to loosen the purse strings to help reflate its European neighbours are likely continue to fall on deaf ears (the US Treasury has partly blamed Germany’s tight fiscal policies and export-led model and subsequent meagre demand and imports for the eurozone’s economic woes). More positively, weaker oil prices are a boon for EU economies (with the exception of oil-exporting Norway), but the benefits are more likely to accrue to those export-oriented economies with high-value added products in demand in EM – Germany springs to mind but more of that in my next blog.
Japan – the trillion yen question about how to reflate the economy
The Bank of Japan in October announced it would expand its already ambitious bond-buying plan, alongside prime minister Abe’s government spending and structural reform. But past experience suggests that effectively reflating the Japanese economy remains one of policy-making’s great dilemmas.
Emerging Markets – the saviour for some, not all, developed economies
So all eyes are likely to remain riveted on emerging markets. Russia’s growth outlook has certainly deteriorated as international sanctions and lower oil prices start to bite. The scope to boost the economy is very limited as the central bank and President Putin are finding out.
For Asian policy-makers from Delhi to Seoul putting a floor under economic growth, employment and social cohesion remains an overwhelming priority (the memory of the 1990s Asian crisis lives on…). Importantly, many Asian governments have the headroom to ease fiscal and monetary policies – as they did on a far greater scale in 2008-2009. The falling oil price and its downward pressure on inflation and cost of oil-price subsidies is yet another incentive to loosen policy.
In Korea, we’ve had Choinomics (a 3% of GDP stimulus package announced in July) and in India Modinomics. Rumours have circulated that Chinese GDP growth this year and next will fall below the government’s 7.5% target (a “hard landing”) but the scope for new and wider reflation tools remains generous in my view. The central bank, which holds nearly $4 trillion in FX reserves, recently injected liquidity into banks and I expect further injections if lending and growth softens. These reflation policies should bring a modicum of relief. In the longer-term I think western governments and companies will continue to pin their hopes on emerging markets’ ongoing shift from an export-driven model to one of greater consumption and imports (the great “rebalancing”). More of that in my next blog.
Olivier Desbarres currently works as an independent commentator on G10 and Emerging Markets. He is a former G10 and emerging markets economist, rates and currency strategist with over 15 years’ experience with two of the world’s largest investment banks.
 Germany posted a record-high current account surplus of $254bn in 2013, vs China’s surplus of $182bn.
 Asian economies benefit from falling oil prices, with perhaps the one exception Malaysia although the price of its main exports (gas and palm oil) is not particularly well correlated to the price of crude oil
Fig 1: International Energy Agency
Fig 2: International Energy Agency
Fig 3: IMF, October 2014
Fig 4: IMF, October 2014