Global economic outlook improves, but risks remain
- We believe U.S. annual GDP growth will be 2.5-3.0% for the second half of 2013.
- We think China's GDP growth will average 7.0-7.5% year over year in the second half.
- We think the biggest risk to economic growth at this point is rising bond yields.
Vice President, Global Economist
At the halfway point of 2013, the global economic environment largely is playing out as we expected. While we believe that economic growth for most countries will continue to improve in the second half, some risks have developed and are causing concerns.
U.S. gains momentum
In the U.S., the fiscal tightening through higher taxes and “sequestration” federal spending cuts early in the year resulted in sluggish economic growth in the first half. The Congressional Budget Office estimates these actions resulted in a drag of about 1.5 percentage points this year. U.S. gross domestic product (GDP) looks to have grown at an annualized rate of 1.5 to 1.75% in the first half of 2013. Going forward, we think the economy will gain momentum for several reasons.
First, we think the effects of the fiscal tightening will begin to wane, as consumers seem to be adjusting to the higher tax burden. The sequester is scheduled to result in another reduction to spending in the fourth quarter, which we think will be less onerous than the prior round. With more clarity in the outlook, we think corporate capital spending is likely to improve after weakness in the first half of the year. We believe housing will continue to add to growth, although the pace at which housing has improved could slow because of rising mortgage rates. Finally, we think exports will stabilize because developed market economies seem to be improving. Overall, we believe U.S. annual GDP growth will be in the 2.5 to 3.0% range for the second half of 2013.
The Federal Reserve (Fed) also recently signaled a shift in its asset purchase program. Fed Chairman Ben Bernanke said the Fed probably will begin to taper its purchases of U.S. treasuries and mortgage-backed securities later this year – most likely in September – with the goal of ending purchases in the middle of 2014. Markets reacted negatively initially, with equities falling and bond yields rising, but then stabilized. If this weakness were to continue, we think it would put pressure on economic growth. Members of the Fed have been quite vocal in recent speeches in an attempt to reassure markets that any tapering would only take place if the economy and labor market continue to improve. They also have been clear that Bernanke’s comments were not a signal that they will tighten monetary policy by raising interest rates earlier than what markets generally had expected.
The U.S. dollar also was stronger in the first half of 2013. We think this is the start of a sustained gain in the dollar over time and believe that several factors will support it:
- Better relative growth, as we think the U.S. economy will outperform its developed market peers over time;
- Monetary policy that is “less loose” in the U.S., compared with other countries, resulting in relatively higher interest rates;
- A declining U.S. budget deficit, which we think will continue to improve on the back of spending restraint and higher tax revenues;
- An improved U.S. current account deficit, which we think will get further support from the U.S. energy boom.
A stronger dollar could have implications for a number of things. These include lower commodity prices over time as well as relative outperformance of U.S. equities versus other global equity markets, particularly in emerging markets.
Europe looks to second half
The economy in Europe continued to progress as we expected during the first half. Eurozone GDP growth reached its weakest point of 2012 in the fourth quarter with a decline of -0.6%, followed by a decline of -0.2% in the first quarter of 2013. We think GDP growth will be similar, if not a bit better, in the second quarter. We continue to believe the second half of 2013 will bring about slightly positive growth in the eurozone, based on less fiscal austerity, a slowdown in the pace of deleveraging and more stable exports. This is not to say that economic growth in the eurozone will be strong – in fact, we believe it will be sub-par for years to come. But we think the risks to significant declines in activity have abated for the time being.
In our view, the European Central Bank (ECB) continues to run monetary policy that is too tight for the current environment. The ECB has indicated that it feels constrained against easing further under its current mandate. Thus, aside from minor policy changes, we think further action from the ECB will be minimal in the immediate future.
Japan reacts to stimulus
Economic growth in Japan has been a positive surprise so far this year. Following Prime Minister Shinzo Abe’s dramatic moves of installing new dovish leadership in the Bank of Japan (BOJ) and implementing short-term fiscal stimulus, GDP in Japan looks to have grown at an annualized rate of about 3.5% in the first half. The move to appoint Haruhiko Kuroda to head the BOJ was followed by the April 4 announcement of a massive easing campaign by the central bank. The Japanese yen then weakened by more than 10% in about six weeks, which followed a decline of more than 15% in the prior six months. These events coupled with what seems to be unending rhetoric about economic stimulus and reforms seems to be changing expectations within Japan. As a result, consumer spending has accelerated and we think exports may be bottoming. We think corporate capital spending will recover next.
Going forward, we think the BOJ and prime minister will continue to provide plenty of liquidity and increasingly focus on reforms. In our view, one risk on the horizon is the planned increase in Japan’s value-added tax (VAT) scheduled to take effect on April 1, 2014. We think this will result in an increase in demand as consumers front load their purchases prior to the higher rate. However, there is concern that Japan’s growth will slow dramatically after that date because of the higher tax. We think annual GDP growth in the second half of the year will be 3.5 to 4.0%.
China slows, restrains emerging markets
Economic growth in emerging-market countries was relatively muted in the first half of the year, restrained by weak growth in developed markets and a slowdown in China. Higher bond yields in the U.S. also have resulted in weakness in emerging market asset markets and currencies, which we think will continue to be a drag on growth going forward.
In China, the new government surprised markets by attempting to address structural problems in the economy, including corruption and excessive risk taking in the banking system (often called the “shadow banking system”). This has caused GDP growth to slow more than expected. China’s GDP growth had a temporary bounce in the fourth quarter of 2012, reaching 7.9% on a yearover- year basis, but we think it will average a bit more than 7.5% in the first half. We think growth will continue to be soft because the recent clampdown on the banking system is likely to slow credit growth going forward. If developed markets strengthen in the second half of 2013, as we think is likely, then we believe exports will provide some offset to this weakness. Overall, we think GDP growth will average 7.0 to 7.5% on a year-over-year basis in the second half.
Economic growth continues to be sluggish in India, although it seems to have stabilized. However, the government has moved more slowly than expected on implementing the reforms needed to boost growth. Recent weakness in the Indian rupee also could prevent the Reserve Bank of India from cutting interest rates further, which we had thought was likely in the face of a lower rate of inflation. Nevertheless, we think economic growth is likely to improve somewhat because of lower inflation and continued gradual progress on reforms. We think GDP growth will be 5.5 to 6.0% in the second half of 2013 after averaging 5.0 to 5.5% in the first half.
Growth continues, but risks remain
The global economy continues to expand, but we think there are several risks to future economic growth. We think the biggest one at this point is from rising bond yields. They already have increased following the Fed’s move toward a less-stimulative stance. If markets continue to take bond yields higher, we think interest-sensitive areas of the economy would be at risk.
We also think rising bond yields in the U.S. would continue to put pressure on emerging-market growth. In addition, if recent moves by the new government in China continue at a more aggressive pace than expected, we believe it would lead to weaker growth than what we anticipate now. In the Middle East, social unrest continues to be a problem and we think it could push oil prices higher. In fact, the risks in the region seem to be increasing, with increasing violence and a military-enforced change of government in Egypt and continued rebellion in Syria. Finally, we cannot rule out what we would consider a policy mistake in the U.S. or Europe, where government leaders continue to deal with widespread economic issues.
Past performance is not a guarantee of future results. The opinions expressed in this article are those of Mr. Hamilton and are not meant to predict or project the future performance of any investment product. The opinions are current through July 5, 2013. Mr. Hamilton’s views are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed.
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