Global Economic Overview: November 2015
Global Growth Outlook Continues to Stabilize
The upward revision in third quarter U.S. economic growth and buoyant consumer sentiment supports a more stable global economic outlook for the next few quarters. Consumer optimism also remains healthy in Europe, though the Euro-zone economy expanded less than expected during the third quarter. The Japanese economy declined during the July-September period, according to initial estimates, but the data could be revised higher as capital investments for the period were greater than initially calculated. Among the emerging countries, India reported faster third quarter growth while South Africa expanded at a moderate pace and avoided recession. However, Brazil and Russia slipped deeper into recession as energy and commodity prices declined further.
The U.S. Federal Reserve is now widely expected to announce a rate hike in December, as the U.S. labor market has strengthened more than expected in October and November. The European Central Bank has announced that it will now extend its bond purchases through March 2017, from the earlier schedule of September 2016. The ECB will also reinvest the funds from maturing bonds in its portfolio for as long as it is required.
Global equity prices corrected in November as the prospect of a rate hike in the U.S. increased. Global manufacturing growth was stable in November, when compared to October, as most developed countries continued to see gains. Manufacturing growth remained subdued in emerging countries, though the improvement in new export order flows points to the possibility of a revival in the coming months.
GLOBAL INDUSTRY SPOTLIGHT FOR THE MONTH: BANKING
Most large banks in the U.S. and Europe have seen healthy earnings growth this year so far, helped by the improving credit demand as central banks continue to keep interest rates at record lows. Regulatory restrictions introduced in the aftermath of the 2008 financial crisis continue to limit proprietary trading operations and other businesses that are deemed risky. Nevertheless, the large banks have been able to cover the earnings shortfall through higher interest income as well as fee income from advisory and intermediation services. While this buoyancy in earnings growth could continue in 2016, regulatory pressure to raise more capital could bring new challenges in future years.
The first nine months of this year have been fairly positive for the banking industry in the developed world. Their operating environment has improved when compared to recent years and this was reflected in the reasonably healthy earnings growth for most large banks. In the U.S., average bank earnings increased more than 5 percent during the third quarter, according to the FDIC. Only 5 percent of the reporting banks were unprofitable during this period, and bank failures have become rare. Credit demand continues to improve, helped by the positive consumer sentiment and low borrowing costs.
The Federal Reserve’s surveys show that residential mortgage demand remains stable. Legal costs for settling misconduct allegations prior to the 2008 financial crisis have also been mostly paid off by the large U.S. banks.
Most large European banks, except select banks that are still restructuring or struggling with top management changes, have also reported positive earnings so far this year. Credit demand continues to improve, both from consumers and businesses. Euro-zone household credit demand increased more than a percent in October while credit demand growth from businesses was also positive. This trend is likely to sustain as the European Central Bank (ECB) has extended its bond purchases for a longer period to keep borrowing costs low. The ECB’s decision to increase the cost for keeping funds with the central bank could force banks to increase lending.
The Japanese banks have benefited from credit growth in the rest of Asia in recent years. The yen’s decline added to their advantage by increasing the translated earnings from overseas operations. However, the third quarter was relatively subdued as credit demand weakened in the rest of Asia. The yen has also stabilized while income from trading operations is not growing as fast as earlier.
Banks in many emerging countries continue to face difficulties as the economies of commodity exporting countries have faltered. Central banks in many of these countries have increased rates this year to stabilize their currencies and limit inflation risks from higher import costs. On the positive side, central banks in China and India have cut interest rates this year and credit demand has seen moderate improvement. However, weakness in the manufacturing sector continues to keep bad loan risks relatively high for the banking industry in China and India.
In the coming years, the global banking industry will be required by regulators to expand their capital base to prevent a repeat of the 2008 financial crisis. The Financial Stability Board (FSB), a global institution based in Basel, Switzerland, has published new rules for the largest banks that are considered systemically important or ‘too big to fail’. The new plan calls for the 30 largest global banks to increase their capital cushion to 16 percent of assets by 2019, and 18 percent by 2022. The FSB estimates that these banks need to raise an additional $1.2 trillion to meet these rules. This could be a challenge for some of the European banks that are still going through restructuring, or are based in countries with a relatively weaker economic outlook.
The U.S. Federal Reserve has published its own guidelines for the large banks, which will be forced to hold more equity and long-term debt on their books. If capital markets remain healthy, the large U.S. banks are unlikely to face much difficulty in raising the additional capital to meet Fed rules. However, rating agency Standard and Poor’s has lowered the credit ratings for the holding companies of eight large U.S. banks. The rating agency believes the new rules make it less likely that the Federal Reserve will readily support these banks during a crisis – as the central bank did in 2008.
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