Prospects still slim for major global economic pickup

December 22, 2015

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The world economy may be set for another year like 2015, with modest growth in developed economies offsetting persistent weakness elsewhere but generating very little inflation and keeping interest rates low.

The U.S. Federal Reserve’s long-awaited rise in rates from zero showed confidence in the world’s largest economy, but rival China is still struggling for a foothold with rate cuts.

Although some countries, such as Brazil, have mainly home-grown inflation troubles, the Fed’s first post-crisis rate hike is an unlikely cure for what ails the rest of the world.

With exchange rates dominating the policy debate in many countries, what happens to the dollar will matter a lot.

“The key question is whether the U.S. economy is finally robust enough not only to sustain its own recovery but also to lift world trade and global growth enough to allow the external deflationary pressures weighing on U.S. inflation to wane,” outlined HSBC economists Janet Henry and James Pomeroy.

Along with an abrupt downturn in the volume of global trade and a continuing fall in commodity prices, the dollar’s rise this year has brought U.S. industrial growth to a near-standstill, keeping a lid on inflation pressures from abroad.

carney-206x300.jpgThe other extreme, according to HSBC, is that the United States, “via a strong U.S. dollar, will simply become the latest victim of the deflationary pass-the-parcel which has plagued the global economy for a decade, and find itself following all of the other developed market central banks which raised rates but soon found they had to reverse course.”

“The outcome, we believe, is likely to be somewhere in between.”

A Reuters poll of 120 economists on Friday forecast the Fed would hike rates again in March, but probably won’t move as quickly next year as policymakers have suggested.

The polls point to global growth averaging only 3.4 percent next year with scant prospect of touching 4 percent given the slowdown in China and the gloom surrounding emerging markets.

Other recent Reuters surveys of hundreds of analysts worldwide do not offer hope for a pickup in inflation, even in the United States where the central bank says it is reasonably confident this will happen. Even the most optimistic core inflation forecasts are not far above 2 percent.

Nor is it easy to find analysts expecting broad weakness in the dollar, with the most aggressive views suggesting the euro could even fall below parity.

European Central Bank (ECB) President Mario Draghi reacts during the bank's monthly news conference in Frankfurt July 3, 2014. The European Central Bank left interest rates unchanged at record lows on Thursday, holding fire while it assesses the impact of a barrage of measures launched last month to pep up the flagging euro zone economy.            REUTERS/Ralph Orlowski  (GERMANY - Tags: BUSINESS POLITICS) - RTR3WYERChina’s renminbi, now a reserve currency, has fallen each day for most of the past two weeks, with many bracing for further devaluation by Chinese authorities still looking for ways to stimulate the debt-laden economy.

SOME HOPE EMERGING

The U.S. growth and inflation outlook is bleaker than forecast this time last year, even after a sharp fall in unemployment. Wage inflation has picked up, but by less than many had thought it would.

Wall Street stock indexes are trading near their levels of a year ago, confounding predictions of a solid rise in 2015, with strategists still expecting them to climb despite downward pressure on earnings.

Over the past year, global fund managers have cut their recommendations for equity holdings to near their lowest since the financial crisis, even as they ramped up bond holdings.

U.S. Treasury yields are not far from where they were this time last year either, but they too are expected to climb, as has been the forecast for many years now, although by less this year than one might expect.

Since crude oil prices began falling sharply 18 months ago from above $100 a barrel to below $40 now, the number of analysts predicting a rebound has dwindled. Some are now saying $20 is more likely than a sizeable move higher.

Inflation commodities

 

But there are some bright spots.

Underpinned by the European Central Bank’s 60 billion euros a month of bond purchases, the euro zone is finally generating modest growth and unemployment has begun to fall.

Inflation remains well below target, however, and so ECB stimulus, including the negative deposit rate, will remain in place for all of next year. That puts the world’s largest trading bloc — and most other central banks — on an opposite policy path to the Fed.

PRES-central bank rates

 

Some emerging market economies are performing better, too.

India is forecast to grow at a decent clip, underpinned by rate cuts earlier this year during a window of low inflation. And optimism about Mexico has grown as it slowly starts to take advantage of a recent historic reform in the energy sector.

Brazilian Central bank chief Alexandre Tombini attends a meeting at the Economic Affairs Committee (CASE) of the Senate in Brasilia December 16, 2014. Tombini repeated on Tuesday that the bank's forex intervention program has met its goals and that the current stock of swaps has fulfilled businesses' demand for currency protection. The comments raised doubts about the continuity of the bank's currency intervention into 2015. Tombini clarified, however, that the bank is currently deciding on new terms for the program that will take effect as of next year. His comments were not enough to ease investors' concerns. The real weakened further after he spoke, trading at 2.781 per dollar, nearly 2 percent weaker, as the market expected more details on the program that currently sells $200 million worth of currency swaps per day. REUTERS/Joedson Alves (BRAZIL - Tags: BUSINESS POLITICS HEADSHOT) - RTR4I9AT

But much can still go wrong. Food prices have already pushed Brazil’s inflation above 10 percent during a deep recession and could rise further.

“As if predicting exchange rates and interest rates wasn’t hard enough, a strong El Niño may be arriving,” warned BofA-ML head of global emerging markets fixed income strategy, Alberto Ades. “So economists and investors will need to keep an eye on the weather, too.”

With Silvio Cascione in Brasilia and Rahul Karunakar in Bengaluru

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