Is dawn approaching for the global economy?
Updated: Jan 8, 2019
Well, it appears we will know if we have "cracked it” in 2019.
Since the global financial crisis began ten years ago, we the prolonged period of low growth hasn't lit anyone's fire. Some, Mark Alexander, Redstone's Head of Strategy included, think that historically low, interest rates, have papered over a recession in Europe. However, that seems to have changed in the last few months.
Redstone's Mark Alexander said: "Look, I don't know if I'd go so far as saying we would have had a recession, but there are lots of businesses out there which would have gone to the wall in a low demand/higher rate environment. Whether that would have led to recession conditions is an unknown, it looks likely, but we will never know. What's interesting is what happens now growth looks stronger."
The EU 27's broad economic growth was the surprise of 2017. Business activity indicators are near record highs, consumer confidence is strong, and the Q3 growth (2.5% YOY) was the healthiest we have seen for ten years. The ECB's soft monetary policy and clear forward guidance has allowed the financial system to heal and has helped build business and consumer confidence resulting in more investment and spending in mainland Europe.
Economic growth around the world is now a reality and the prospect of central banks moving away from their super-loose monetary policy very real. The Fed's rate is now the highest since 2008, and the European Central Bank finishes its taper this month and has pledged not to increase rates before the summer. The Bank of China has breathed out as Trump pulled back from the brink of his deep. Only Bank of Japan continues to deliver massive stimulus.
Redstone's Mark Alexander said: "People are talking about the Fed going to 3.5% by 2020. That feels toppy but could happen if the truce in the US-China trade dispute struck by Trump and Xi this weekend holds. Inflation looks a concern still, but overall the US is healthy. Inflation in the Eurozone is growing, and growth is encouraging and broad-based."
Bank of England Governor Mark Carney, who recently extended his term to help manage Brexit, voted to bring borrowing costs to the highest since 2009, and the market is signalling it thinks the next rate hike will happen in May.
Redstone's Mark Alexander said: "In the UK the big question is what happens in April 2019. Will Leave get their act together, and the U.K. formally leave the EU and if so what shade of Brexit will it be? There is a Commons Vote on the deal on the 11th December- If prime Minister May's deal is voted down (Ed. As looks likely), there are two routes. If the transition is turbulent, the BOE may not be able to help with a cut as it did after the referendum. It may even have to raise rates even faster than planned to keep a lid on excessive inflation. If there is a People's Vote, as being called for some politicians and the majority of voters, we face uncertainty. The upside case is that the UK remains part of the EU with all the economic benefits that brings."
Whereas it's clear that high inflation in the UK, which hit 3%, has been caused by the Brexit vote the US's low inflation is a mystery. Does this weakness reflect a temporary set of factors, or is there something more structural going on?
"Redstone is focused on the "what if?" of the structural side of this. We are wondering what the Fed, the ECB and BoE can do to combat deflationary forces like globalisation, demographics and technology-driven productivity improvements and inflationary forces like Brexit. If low inflation is transitory - which could be explained by Obamacare and the shift to unlimited call plans by mobile telco providers - then the risk is very low."
So, the macroeconomic situation looks brighter; the Central banks could sneak in a few rate rises over the next couple of years, which would provide them with a welcome cushion to deal with any future economic shocks.
What happens next? The world’s fourth-largest economy, Japan, is in the midst of its second-longest economic expansion since World War II. It has grown for seven successive quarters fuelled by Bank of Japan's ultra-easy monetary policy, which looks set to continue with 10-year Japanese government bonds at around 0%- They aren't likely to move away from that policy. The People’s Bank of China (PBoC) will likely seek to mitigate systemic and Trump risk with a bias toward monetary policy tightening bias and leverage controls and tightening in the housing sector. Newly installed Fed Chair Jerome Powell is signalling another rate hike in December and more in 2019. BoE will do what it can to limit Brexit led inflation, but if the UK does leave the EU, it will find itself in low rate environment, with the need to go even lower. We can expect the ECB to aim for some small and scope limited rises end of Q3 once they understand more about Brexit.
Redstone's Mark Alexander said: "There are brighter signs for the global economy, but we are in a period where unprecedented loose monetary conditions have created unpredictability and reduced the efficacy of the arsenal of weapons the central banks have to avoid recession. If the business and monetary cycles sync on a downturn in 2020, it's tough to see how the central banks could deal with it. However, that risk was higher in 2017/18 than it looks in 2019 so overall I'm mildly positive on the global economy. I'd characterise it as less gloomy with rays of sunshine."