Low Fuel Costs Helping the U.S. while Resource Exporters Struggle
The fall in energy and commodity prices continues to drive the divergent economic trends in the U.S. and other countries in the region. While the low fuel costs have supported the ongoing healthy U.S. economic expansion, the resource exporting countries in the region continue to struggle. Brazil remains in an economic recession even as political controversies have worsened the outlook for the country. The recent downgrades by the credit rating agencies have led to significant capital outflows from Brazil, making it difficult for domestic corporations to finance growth. The political environment in Canada has turned brighter after the election of the new government and the economy is showing modest signs of a recovery, helped by domestic demand. However, without a meaningful rise in oil prices, it will be difficult for the Canadian economy to expand faster.
In Latin America, Mexico is expected to benefit from higher U.S. consumer demand. However, lower oil prices will restrict the Mexican government’s public spending and lower potential growth. The steep fall in currencies of most Latin American countries have heightened inflation risks, and have forced their central banks to take preemptive policy tightening measures. Central banks in Brazil, Chile, Peru, and Colombia have increased their benchmark rates this year, despite the weak economic trends. Higher rates are essential to slow capital outflows and limit further currency declines, but could also restrict domestic consumer demand in these countries.
At a Glance
United States: Though the initial reading of U.S. economic growth for the third quarter was lower than expected, the outlook for the coming quarters turned brighter after a strong October jobs report. Consumer sentiment remains robust, helped by wage gains and low fuel prices. The Federal Reserve is now expected to announce its first rate hike by the end of this year.
Canada: The Canadian economy appears to be slowly recovering from a decline caused by the sharp drop in energy exports during the first half of the year. The new Canadian government is expected to increase public spending, especially in infrastructure, over the next several years.
Brazil: Continuing political uncertainties have worsened the outlook for Brazil’s economy, buffeted by the steep fall in prices of industrial materials such as iron ore. Popular support for the current government has slipped to the lowest level on record as the president is facing potential impeachment.
Mexico: Lower oil exports, reduced public spending, and the weaker than expected overseas demand for manufactured goods are likely to limit Mexico’s economic growth. Domestic consumer demand is expected to support the economy, as retail sales have been stronger than estimated in recent months.
Chile: The Chilean government expects the economy to expand 2.25 percent for the whole of this year, after growth slowed to slightly over 2 percent during the first half. Despite the slowdown, the Chilean central bank was forced to increase its benchmark interest rate in October as inflation remained above the target range.
Peru: Economic growth forecasts for the current year as well as 2016 have been lowered by the central bank to 3.1 percent and 4.2 percent, respectively. The Peruvian central bank unexpectedly increased its benchmark rate by 25 basis points in September as consumer inflation trended higher.
Colombia: The economy expanded at an annualized rate of nearly 3 percent during the first half of this year, and is forecast to maintain the same pace for the rest of the year. Consumer inflation was at the highest level in nearly six years in September, forcing the central bank to increase interest rates.
Argentina: A change in government appears more likely in November’s presidential election, after the opposition candidate’s gains in the first round extended the election to the second round. The economy expanded 2.3 percent during the second quarter, helped by increased government spending.
UNITED STATES: STRONGER LABOR MARKET TO SUSTAIN CONSUMER SPENDING
Though the initial reading of U.S. economic growth for the third quarter was lower than expected, select key indicators suggest healthier expansion in the coming quarters. Much of the moderation in third quarter growth was due to lower than expected inventory buildup. As consumer sentiment remains robust, this is likely to reverse during the last three months of the year and early next year. Even during the third quarter, gains in consumer spending exceeded estimates and confirmed the underlying strength in domestic demand. Fuel prices have retreated again and average gasoline prices have moved closer to $2 per gallon. Savings from lower fuel prices are expected to support further gains in consumer spending in the coming months.
The labor market is also strengthening, after remaining relatively subdued during the third quarter, as October job additions were well above expectations. The unemployment rate is now down to 5 percent, though part of the decline is due to the long-term unemployed leaving the workforce. Recent monthly data also show gains in average wages, though at a moderate pace, which should add to consumer optimism.
The U.S. housing market remains healthy, supported by gains in average incomes and low mortgage rates. Existing home sales increased nearly 5 percent in September and, if the pace is sustained, annual sales for the current year could be the highest after the 2008 financial crisis. Average home prices also continue to rise across major cities, as low housing inventories have pushed up prices in the most active markets such as San Francisco. New home sales unexpectedly declined in September, but builders remain confident of future demand and are stepping up new construction activity.
Despite heightened market expectations for an interest rate hike, the U.S. Federal Reserve has so far kept the benchmark rate unchanged. The weaker global economic outlook and the recent volatility in global financial markets have made the Fed more cautious about the possible negative impact on U.S. economic growth. Nevertheless, the better than expected October job additions and sustained wage growth have made a Fed rate hike in December more likely.
CANADA: NEW GOVERNMENT FACES CHALLENGING ECONOMIC TRENDS
Canada elected a new government led by Prime Minister Justin Trudeau, handing an unexpected defeat to the conservative government that was in power for much of the last decade. The new government is expected to increase public spending, especially in infrastructure, over the next several years. It is also expected that the tax code will be altered to favor the middle class and lower income populations, at the cost of high earners. Prime Minister Trudeau’s choice of a former private sector executive as the new finance minister, against the claims of experienced politicians, has been well received.
Meanwhile, the Canadian economy appears to be slowly recovering from a decline caused by the sharp drop in energy exports during the first half of the year. Economic output expanded in July and August, helped by the sustained buoyancy in the housing market and strong domestic demand. Retail sales increased more than expected in August, led by automobile sales that increased more than 9 percent from a year ago. Consumer sentiment has become brighter after the elections on expectations of growth friendly policy initiatives from the new government.
Exports from Canada stabilized during the third quarter and expanded at a marginal pace in September. Though oil prices remain low, aggregate energy exports from Canada increased in September. Gains in shipments of manufactured consumer goods, together with a fall in imports, helped narrow the trade gap for September. However, it is uncertain if these trends can be sustained as global energy demand remains subdued.
BRAZIL: POLITICAL UNCERTAINTIES WORSEN THE ECONOMIC OUTLOOK
Continuing political uncertainties have worsened the outlook for Brazil’s economy, buffeted by the steep fall in prices of industrial materials such as iron ore. Popular support for the current government has slipped to the lowest on record as the president is facing potential impeachment. If the request for impeachment is approved by the country’s National Congress, it will be only the second time in three decades that a Brazilian president faces such a fate. The impeachment process may take several months after parliamentary approval, and the political uncertainties could make it difficult for the government to initiate effective policy measures to counter the economic downturn. The absence of credible political alternatives has made the situation more difficult as some of the opposition leaders are also facing corruption allegations.
Meanwhile, the Brazilian economy continues to weaken and is expected to contract by 3 percent this year, according to a survey conducted by the central bank. The economy is forecast to decline further in 2016, though not as much as this year, before an expected subdued recovery in 2017. Economic trends remained weak during the third quarter as an index of economic activity continued to show declines in July and August. Retail sales have seen a sustained decline in recent months as the unemployment rate increased to 7.6 percent in September, from 5.3 percent at the beginning of the year.
Despite the weak economic trends, high inflation continues to restrict the central bank from lowering interest rates. The central bank’s benchmark rate is currently at a nine year high as consumer inflation rose to 9.5 percent in September. Most economists surveyed by the central bank expect another rate hike before the end of the year, as inflation remains well above the central bank’s target of 4.5 percent. The recent downgrades by the leading credit rating agencies and the weak currency have made the central bank’s job even more difficult.
MEXICO: GROWTH TARGETS FOR 2016 LOWERED AS GOVERNMENT CUTS SPENDING
The decline in oil prices has forced the Mexican government to reduce its spending this year as well as in 2016, which will restrict aggregate economic growth. Government spending will be lower by nearly $8 billion next year in an effort to limit the budget deficit to 0.5 percent of GDP. Revenues from energy production account for nearly a third of the government budget and the significant fall in oil prices has made the government more cautious about public spending. The Mexican government has budgeted average oil prices of $50 per barrel for 2016, substantially lower than recent years.
Lower oil exports, reduced public spending, and the weaker than expected overseas demand for manufactured goods are likely to limit Mexico’s economic growth. Domestic consumer demand is expected to support the economy, as retail sales have been stronger than estimated in recent months. The Mexican central bank currently expects the economy to expand 1.9 percent to 2.4 percent this year. Economic growth for 2016 is forecast to range between 2.6 percent and 3.6 percent.
The Mexican central bank continues to hold its benchmark rates steady, as it waits for the next policy move from the U.S. Federal Reserve. Mexico’s subdued economic growth and low inflation risks should have encouraged the central bank to lower borrowing costs this year. However, the central bank has indicated that higher U.S. rates could probably necessitate a rate increase in Mexico as well to prevent currency weakness and capital outflows.
CHILE: LOW COPPER PRICES CONTINUE TO RESTRICT THE ECONOMY
Economic trends in Chile remain uncertain as one of the world’s largest copper producers continues to suffer from low commodity prices. An index of economic activity strengthened more than expected in September, after declining in August. The gains were supported by an increase in manufacturing activity and higher retail sales. The Chilean government expects the economy to expand 2.25 percent for the whole of this year, after growth slowed to slightly over 2 percent during the first half.
Despite the economic growth slowdown, the Chilean central bank was forced to increase its benchmark interest rate in October as inflation remained above the target range. The central bank has indicated the possibility of further rate increases over the next year if there is no significant slowdown in economic growth and if inflation remains high. Consumer prices increased at an annual pace of 4.6 percent in September, above the central bank’s upper target of 4 percent.
The Chilean government is not planning additional fiscal measures to energize the economy and will instead pay more attention to boosting business confidence. Public spending is expected to rise only 4.4 percent in 2016, compared to a nearly 10 percent increase this year. Mining companies are also lowering their investments as the cheaper commodities have made new capacity additions unviable. Chile’s largest copper producer is reducing its five year investment plan to $22 billion, from $25 billion earlier.
PERU: WEAK CURRENCY AND HIGHER INFLATION FORCE RATE HIKE
The Peruvian central bank unexpectedly increased its benchmark rate by 25 basis points in September as consumer inflation trended higher. This was the first rate hike in nearly four years and the central bank indicated its readiness for more policy measures to keep inflation within acceptable levels. The Peruvian currency has declined more than 10 percent against the U.S. Dollar over the past year and, as a result, import prices have moved higher and inflation topped 4 percent in September.
The weaker currency has not provided much relief to Peruvian exporters so far as aggregate exports from the country have declined this year. Lower prices of industrial metals and other commodities have led to a 16 percent fall in exports for the first nine months, compared to same period of last year. Exports of farm produce increased, but their share in aggregate exports is not large enough to counter the fall in mining.
Economic growth forecasts for the current year as well as 2016 have been lowered by the central bank to 3.1 percent and 4.2 percent, respectively. Aggregate growth improved during the second quarter of this year, when compared to the previous three months, helped by higher mining production that compensated for lower prices. The economy is now expected to expand close to 3 percent during the second half of this year.
COLOMBIA: ROBUST DOMESTIC DEMAND SUPPORTS ECONOMIC GROWTH
Despite the fall in prices of crude oil and industrial commodities, Colombia’s economy continues to sustain a moderate growth pace. The economy expanded at an annualized rate of nearly 3 percent during the first half of this year, and is forecast to maintain the same pace for the rest of the year. Strong gains in construction activity have helped offset the decline in exports and manufacturing. Mining activity also continues to expand at a moderate pace as producers have tried to partly balance the lower prices with higher sales volumes.
The sharp decline of the Colombian peso against the U.S. Dollar has softened the deterioration in the country’s current account. During the first half, the current account deficit widened by 7 percent when compared to the same period of last year. If it were not for the more than 30 percent fall in the peso so far this year, which made exports more competitive and imports costlier, the current account deficit would have been much worse. However, the currency weakness has made foreign investors more cautious and capital inflows have also declined this year.
The Colombian central bank unexpectedly increased its benchmark rate by 50 basis points in October as inflation continued to rise. Consumer inflation was at the highest level in nearly six years in September, and well above the central bank’s 3 percent target. The central bank said stronger than expected domestic demand and higher import prices due to the currency decline have increased inflation risks in recent months.
ARGENTINA: PRESIDENTIAL ELECTION UNEXPECTEDLY EXTENDS TO SECOND ROUND
The Argentinean presidential election will extend to a second round, to be held in November, after the opposition candidate received a higher than expected share of the votes in the initial round. Mauricio Marci, the opposition candidate and the former mayor of Buenos Aires, has promised more business-friendly policies if elected. He has also promised to settle the claims of investors who continue to hold the bonds that the country defaulted earlier. If implemented, these policies would mark a significant deviation from the populist policies of the last several years.
Meanwhile, the Argentinean economy expanded at a moderate 2.3 percent rate during the second quarter of this year, according to government data that independent economists believe are unreliable. The International Monetary Fund also continues to question Argentina’s economic data reliability and has given the country another year to improve data accuracy. Public spending was the primary growth driver during the first half of this year as the government stepped up efforts to boost domestic demand ahead of the presidential election. As a result, the fiscal deficit is expected to exceed 7 percent of GDP this year.
This article is for informational purposes only. This article is not intended to provide tax, legal, insurance or other investment advice. Unless otherwise specified, you are solely responsible for determining whether any investment, security or other product or service is appropriate for you based on your personal investment objectives and financial situation. You should consult an attorney or tax professional regarding your specific legal or tax situation. The information contained in this article does not, in any way, constitute investment advice and should not be considered a recommendation to buy or sell any security discussed herein. It should not be assumed that any investment will be profitable or will equal the performance of any security mentioned herein. Thomas White International, Ltd, may, from time to time, have a position or interest in, or may buy, sell or otherwise transact in, or with respect to, a particular security, issuer or market on our own behalf or on behalf of a client account.
FORWARD LOOKING STATEMENTS
Certain statements made in this article may be forward looking. Actual future results or occurrences may differ significantly from those anticipated in any forward looking statements due to numerous factors. Thomas White International, Ltd. undertakes no responsibility to update publicly or revise any forward looking statements.
