Trade may be flagging, global growth at risk: James Saft

July 29, 2014

July 29 (Reuters) – While most investors are transfixed by
trying to anticipate the next jurisdiction-hopping, tax-driven
merger, there are small but growing signs that global growth may
be headed for a slowdown.

Perhaps the most eye-catching figure is the collapse in the
Baltic Dry Index (BDI), a market measure of demand for shipping
capacity, which is down about 65 percent so far this year. With
90 percent of everything traded around the world traveling by
sea, the fall in shipping prices, while probably overstating
matters, is a sign worth paying attention to. The fall in the
BDI is at least in part driven by lots of new shipping capacity
coming online, but there are other indicators that trade
momentum is slowing and could be taking global growth with it.

The volume of global trade fell outright in May, the most
recent month measured, according to data from the Netherlands
Bureau of Economic Policy Analysis, and momentum in global trade
has been in negative territory for much of the year.

That makes the International Monetary Fund’s decision last
week to cut its global growth forecast for this year to 3.4
percent, from 3.7 percent in April, easier to understand, though
the underlying economic mechanisms are far from simple.

In part this is a pure story about the U.S., whose economy
actually shrank in the first quarter at a brisk 2.9 percent
annual clip. The IMF has downgraded U.S. growth expectations to
1.7 percent for the full year, but this is far from being a sure
thing. Though U.S. manufacturing and consumer confidence are
strong (the latter buttressed in part by peppy asset markets),
housing has emerged as a weak spot, with mortgages reportedly
hard to obtain and new home building slumping. Remember too that
the U.S. economic expansion is now in its 61st month, against an
average expansion length since 1854 of just 39 months.

If U.S. GDP data due out on Wednesday fails to show the
rebound most economists are predicting, it is likely the tenor
of the conversation about global growth turns considerably
gloomier.

And while the U.S. is the engine, there are broad-based
signs that growth is less healthy than it was at the end of last
year, notably the fact that the annual rate of growth in the
leading indicator put together by the OECD is now only a bit
more than half what it was last November.

KEY ROLE OF FINANCING

This may not be a simple story of a cyclical slowdown.
Public debt markets are red-hot, so much so that regulators are
now trying to tamp down investors’ enthusiasm for risky loans
and bonds. But many markets which depend on bank-originated
financing are having a more difficult time, at least in part
because many banks are seeking to raise capital to conform to
new regulations.

A 2013 survey by the Asian Development Bank found unmet
demand for lending and trade guarantees equal to $1.6 trillion
in trade. Banks taking part in the survey blamed a host of
factors, all of which were tied in one respect or another to
banking system capital and creditworthiness.

Along the same lines, rules drafted after the financial
crisis intended to prevent another subprime mortgage crisis are,
as is appropriate, making it harder for some would-be borrowers
in the U.S. to get credit.

A dearth of bank financing is also key to economic fragility
in the euro zone, which is itself far more dependent on bank
loans to fuel growth than is the U.S., which has larger public
capital markets.

Euro zone loans to the private sector fell by 1.7 per cent
in June from the same month a year earlier, according to ECB
data released on Monday, a less rapid pace of contraction than
the month before but still a sign of a massive credit crunch.

While the ECB has taken steps to make it more expensive for
banks to park cash with it, and may move later this year to
outright asset purchases, the process of rebuilding confidence
in and of European banks will be a long one.

While we can’t know whether any of this indicates an
upcoming global slowdown in growth, we can consider where one
would leave investors.

Asset markets, to put it mildly, are not priced for a
recession, or anything close. Expectations underlying valuations
assume healthy profit margins, some overall growth and continued
support from central banks in the form of low rates.

Nor are central banks well positioned. There is no room for
interest rate cuts and the track record of asset purchases is
mixed, and should we get a real slowdown, would look even worse.

Trade data is slow moving and hard to parse, but looks to be
critical in coming months.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be
an owner indirectly as an investor in a fund. You can email him
at jamessaft@jamessaft.com and find more columns at blogs.reuters.com/james-saft)

(Editing by James Dalgleish)

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