We assess ‘the good, the bad and the ugly’ trends we see across the globe
The world economy and financial markets have been buffeted over the past year by national and geopolitical shocks, yet the current synchronized upswing across the world’s largest economies — the first since the global financial crisis (GFC) — remains unscathed so far. Growth is up but inflation is low, and major central banks remain accommodative amid monetary policy normalization in the US. Asset price valuations are stretched, yet yield hunger — if not outright yield starvation — persists.
In the view of Invesco Fixed Income, three key themes have emerged across geopolitics, national economic policies and the financial markets. We call them the “the good, the bad and the ugly.”
- The good: The synchronized global cyclical upswing will likely continue, in our view. This would mean good growth with inflation generally below major central banks’ targets — a situation that would encourage policy normalization but without too much tightening.
- The bad: In the longer term, however, the trends don’t look as positive. Adverse demographics and low productivity growth are likely to restrict economic growth prospects in developed and emerging markets.
- The ugly: Key political and policy threats in the US, Europe and China represent downside risks to the current cyclical upswing.
The good: First synchronized cyclical global upturn across major economies since the GFC
Easy monetary policy is helping to drive above-trend growth in the US and the eurozone. Even though the Federal Reserve (Fed) has tapered, is now tightening and is likely to reduce its balance sheet size, financial conditions remain fairly easy with a soft US dollar, relatively low real interest rates and buoyant stock markets — all of which support growth.
Easy money has also helped support UK growth, despite the risks from Brexit (although now, the UK economy is slowing amid rising inflation). Japan is finally growing above trend, benefiting from both easy money and global recovery. China is the one large economy where easier policy has arguably worked too well, with growth and inflation running above target — hence the People’s Bank of China (PBoC) is actively tightening.
While growth is perking up, inflation has been largely missing in action. With inflation expectations already subdued, labor productivity low and credit trends in many major economies modest after the housing bubble excesses, the risks are asymmetric: Inflation expectations are more likely to shift downward into disinflation — even toward deflation — than upward to high and rising inflation.
Low inflation means that major central banks are duty-bound to maintain relatively loose monetary conditions. An environment of low inflation and steady growth could help elongate the credit cycle by allowing central banks to maintain easy monetary stances for longer, which we believe sets up a supportive environment for credit assets.
The bad: Productivity and demographic trends threaten longer-term growth
The long-term growth outlook is not as bullish, however. Developed markets are experiencing weak labor force and productivity growth, and inflation is likely to remain low, perhaps below targets. There is as yet no convincing explanation or solution for the fall in productivity growth since the GFC, but it does seem to be a fact of life.
Deteriorating demographics are another fact. Following the baby boom generation, labor forces across most developed markets have peaked or are already shrinking, and populations are aging. Some key emerging markets are already following the same path for various reasons — notably China, Russia and Central Europe; and others will likely follow, notably Brazil.
The ugly: Geopolitical and policy risks loom
China. China has supported the current global upswing by addressing its growth and economic rebalancing challenges of 2015 and 2016, which had threatened to export a deflationary shock by a sharp devaluation. In doing so, however, it has reflated economic growth through rapid credit growth, which may have gone too far. So the PBoC is now tightening monetary and credit policies, creating concern about over-tightening. In addition, supply-side and state enterprise reform might accelerate after the October–November National Party Congress, which might also slow global growth. These risks are worth monitoring very closely, though the likelihood is that the PBoC will ease up on the brakes if the economy starts to slow too rapidly, given the high priority of its 6.5% growth target.
US. The prospect of restrictive trade and immigration policies remains a risk to globalization. In addition, President Donald Trump will likely need to recast much of the Fed’s Open Market Committee in the coming year. Some members of Congress would like a more hawkish, rules-based Fed, but others might want easier policy and a weak dollar to encourage investment and hiring in the manufacturing sector, as they eye the 2018 midterm elections. In all likelihood, the difficulty of radical policy change in the US political system suggests that much of this is noise and will not come to fruition. Indeed, equities have been priced for deregulation, tax reform and fiscal stimulus, and bonds and currencies have been priced for low inflation and no real change in trade policies. The risk is that a political shift could disrupt this consensual complacency.
Eurozone. On balance, signs point to subpar growth, rather than event risk or disintegration of the European Union (EU). The election of French President Emmanuel Macron, who ran on a pro-EU/eurozone and open economy platform, and his large majority in Parliament significantly reduces short-term event risk. Italy will probably resist radical reform and may yet represent an existential threat to the euro; the coming election due in early 2018 could be another crucial milestone in both Italian politics and EU integration. Germany is likely to maintain a preference for harmonization of major budget, social security and financial-sector policies instead of full EU integration. This policy outlook suggests continued eurozone stability amid low inflation and the continuation of easy European Central Bank (ECB) policies, allowing scope for the tapering that is around the corner. Here again, the longer-term risk is that markets are lulled into yield-seeking, raising the risk that the eurozone is not robust enough for the next shock or slowdown.
There is also a near-term risk that the ECB may overdo it as it embarks on its own tapering, in a potential rerun of the Fed-triggered “taper tantrum” that undermined risk appetite in 2013 and 2014. However, we believe this risk will be well-managed by the ECB, which has the Fed’s playbook to build on. Furthermore, as the ECB catches up to the Fed, the dollar is likely to remain soft, which is typically very supportive for global financial conditions and growth, because of the dollar’s role in international finance and in commodity and goods trade.
UK. Delays are likely in Brexit negotiations due to domestic political instability, in turn raising both the hope that Brexit might not happen after all, and the chance of the most negative scenario — that the UK “crashes out” of the EU with no deal or transition period. This risk is mostly UK-specific, though there might be some spillover to the rest of the EU and some fear of global risks if talks are acrimonious, or if there are hints of trade war.
The long term outlook: Yield starvation despite risks
The combination of a decent but non-inflationary growth cycle and deflationary risks implies gradual, limited monetary policy normalization by major central banks. Beyond the current cycle, steady-state global interest rates will likely remain low compared with history in nominal terms, given low trend growth and inflation. Our low-growth, “low-flation” world will likely remain starved for yield, driving fund flows into risky asset classes, despite the event risks that almost surely lie ahead.
Head of Emerging Market Sovereign and Macro Research
Arnab Das is responsible for global emerging markets macro research for Invesco Fixed Income, and works with both the macro and emerging markets teams. He joined Invesco in 2015, and is based in London.
Mr. Das began his career in finance in 1992. He has served as co-head of research at Roubini Global Economics, co-head of global economics and strategy, head of FX and EM research at Dresdner Kleinwort, and head of EEMEA research at JP Morgan. He has also been a private consultant in global and emerging markets, as well as consulting with Trusted Sources, a specialist EM research boutique in London.
Mr. Das’ studies were in macroeconomics, economic history and international relations. He earned an AB from Princeton University in 1986 and completed his postgraduate and doctoral work at the London School of Economics from 1987 to 1992.
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