Global Economic Perspective: April by Franklin Templeton Investments
Perspective from the Franklin Templeton Fixed Income Group®
IN THIS ISSUE
- Federal Reserve Grapples with Mixed US Data
- Global Economy Facing Challenges
- European Recovery Broadens and Strengthens
Federal Reserve Grapples with Mixed US Data
The first quarter of this year brought its share of disappointments in terms of US economic indicators. Weak consumer spending, combined with slowing factory activity and housing starts, in the opening months of 2015 all pointed to the likelihood of a meaningful moderation in US economic growth in the first quarter. Observers pointed to severe weather in January and February to explain poor data. But March also saw a major downward shift in job creation and in manufacturing data. Industrial production posted its biggest drop in more than two-and-a-half years in March as oil and gas well drilling plummeted. Declining investment in energy projects can be expected to have dented gross domestic product (GDP) growth in the first quarter overall. In addition, US home construction rose much less than a Bloomberg survey of economists expected in March, in spite of more favorable weather.
The question is whether this weakness will be prolonged, or whether we will witness a return to better growth trends, just as we saw in 2014, when growth shifted dramatically from an annualized rate of -2.1% in the first quarter to 4.6% in the second quarter. We think there remain grounds for cautious optimism on this score. Although deemed disappointing on some measures, retail sales did rise in March for the first time in four months as shoppers returned to stores after the winter cold snap. And although the overall trend during the past six months has remained decidedly mixed, we believe it is reasonable to expect that the substantial increase in new jobs over the past year, together with the significant decline in gasoline prices, should continue to boost consumer spending in the months ahead. On the corporate front, while industrial production figures have disappointed, expansion of the US services sector has continued apace, with the Institute for Supply Management’s Non-Manufacturing Index reading coming in at 56.5 in March, well above the 50 level that separates expansion from contraction. Just as significantly, lending both to businesses and to consumers has been picking up, showing there is demand in the economy. As energy prices have tended to stabilize, the upturn in demand has begun, finally, to be seen in some inflation figures, with producer prices in the United States rising in March for the first time in six months.
But in financial markets, early signs that US growth might be firming have been obscured to some degree by the sluggish growth in corporate earnings, caused in part by the upward lurch in the value of the US dollar, by the downturn in the energy sector’s fortunes and by weak global growth.
And, in our view, there can be little question that the spate of decidedly mixed economic data of recent weeks leaves the US Federal Reserve (Fed) facing a policy dilemma at a crucial juncture. The Fed noted in March that economic growth had “moderated somewhat,” an admission that indicates some hesitancy about the timing of interest-rate hikes. No doubt recent data disappointments will serve to cast some doubt on an initial rate hike occurring in June. In particular, the weak nonfarm payroll numbers for March (and downward revisions to figures for previous months) could be used as excuses for the Fed to sit on its hands for a while yet before moving to normalize monetary policy. Nonetheless, some senior Fed policymakers continue to believe that the “temporary factors” that hurt US economic growth in the first quarter are likely to quickly dissipate and that the economy should accelerate in the months to come.
In a nutshell, the Fed seems to be wrestling with itself about the actual timing of rate increases. With the Fed’s dilemma potentially causing anguish among market participants, the central bank has been trying to communicate that rate increases, when they come, will be small and gradual, in keeping with its own reduced projections for economic growth up to the end of 2016. The Fed’s efforts to calm markets are laudable, and weak first-quarter data may suggest it can continue to be patient before making a move. At the same time, the Fed no doubt hopes that after six years of near-zero interest rates it can normalize policy sometime soon, with Fed Chair Janet Yellen stating on March 27 that the Fed might not even wait for healthier core inflation and wage growth before raising borrowing costs.
Global Economy Facing Challenges
In its latest World Economic Outlook (WEO), released in mid-April, the International Monetary Fund (IMF) said that global growth remains moderate, with “uneven prospects” across different countries and regions. Global growth, having come in at 3.4% in both 2013 and 2014, is now seen by the IMF as picking up only slightly to 3.5% in 2015,1 with modest improvements from the so-called advanced economies offset by weaker growth from emerging and developing economies, and with Russia and Brazil particularly weak. The IMF believes global growth should pick up further in 2016, to 3.8%.1 We think global growth moving up to 3.5% this year and showing signs of improvement should not be considered too bad a prognosis, and it would bring the world back in line with long-term trends for global economic expansion. Throughout the mid-1980s, and again in the mid-1990s, real GDP growth in the world also hovered around 3.5%, according to the IMF’s WEO data mapper,2 although we may currently be seeing a rebalancing of growth away from some developing markets toward some developed ones.
Longer term, however, the issues of population aging, slowing investment and declining productivity gains are beginning to impact a number of emerging markets as much as they are advanced economies, pushing down potential growth rates in the eyes of some observers. The world’s second- and third-largest economies in particular face some nagging medium-term challenges. Japan is now well over two years into “Abenomics,” a set of policies meant to combine fiscal expansion, monetary easing and structural reform in a bid to extract Japan from deflation. The results so far have been relatively disappointing, with the country falling into recession again in 2014. Although the decline in the value of the yen and cheap oil have lately helped boost economic data again, some structural reforms have been slow in coming, and it is not at all clear the long-term decline in the Japanese economy is over.
But whereas the world has grown used to Japanese stagnation, it is now having to come to terms with a slowdown in China as well. We would note that in absolute terms, 7% Chinese growth in 2015—the government’s official target—is worth more than growth of over 11% in 2005 since the Chinese economy is so much bigger than it was 10 years ago. And China has the fiscal and monetary flexibility to keep its ongoing shift to a more domestically driven growth model on track. However, “managing” slowing growth is hard, especially when the Chinese economy contains many imbalances (such as what many observers