Thanks to persistent weakness in capex, BAML analysts have trimmed U.S. GDP growth projections, while they have revised upwards their GDP forecast for the euro area.
Ethan S. Harris and team at Bank of America Merrill Lynch published their Global Economic Weekly on May 1, 2015 titled: “Narrowing growth divides”, wherein they anticipate the Reserve Bank of Australia will cut rates at its May meeting this week.
GDP growth: The U.S. economy all but stalled
The BAML analysts note last week’s 1Q GDP report revealed U.S. growth of only 0.2% qoq (saar), featuring marked weakness in external trade and capex components. As the analysts anticipate persistent weakness in capex, they have trimmed GDP growth projections to 2.5% in 2Q from 3.5% previously, taking down 2015 GDP growth to 2.4% from 2.9%.
The analysts point out that although the U.S. economy is expanding at a slower pace, it still seems likely to grow at above-potential rates in the coming quarters. They note with expected firming up of inflation, this will probably could convince the Fed to start hiking interest rates in September.
Harris et al note slower U.S. GDP growth poses a notable drag to the rest of the world (RoW). They point out that a 1% drop in U.S. GDP tends to subtract about 0.3% from RoW GDP. Tamer U.S. growth would in particular likely weigh on Mexico, Canada and other large developed economies, as the U.S. economy absorbs a significant fraction of these economies’ exports:
As can be deduced from the following graph, Canada has the highest correlation with U.S. growth over the long run. The analysts note during the course of the cycle, however, GDP growth in the largest DM economies, Mexico, Hungary and Taiwan correlate strongly with U.S. activity. They note the picture is similar when looking at euro area co-movements:
Studying the correlation of core capital goods shipments and GDP private equipment investments, the BAML analysts note the two move together closely, but differ in part because core capital goods encompass domestic factory goods, whereas GDP measures expenditures by domestic firms on domestic and imported capital. Digging deeper into the durable goods report, they note the drop in core capital goods shipments is entirely due to machinery:
Europe’s GDP forecast revised upwards
Harris and colleagues have revised their GDP forecasts for the euro area up from 1.5% to 1.6% for 2015, and from 1.6% to 1.9% for 2016. Justifying their revision, they point out that their move merely reflects a convergence of the pace of economic activity across both sides of the Atlantic. However, the analysts still think their latest move won’t translate into materially higher inflation given the current high level of slack. They point out that the main downside risk may well be “extra European”, i.e. a significant drop in global demand, triggered by a wobbly U.S. and EM.
Turning their focus to Japan, the BAML analysts note the central bank will likely keep the pace of asset purchase unchanged for the rest of the year, but the situation is data-dependent. As regards Emerging Asia, the team trimmed the Thailand policy rate forecast to 1.5% in 2015 and 1.75% in 2016.
Examining India’s growth, the BAML analysts note rates are more important to recovery than reforms. They point out that reforms will push up India’s potential growth to around 9% in 5-10 years from 7-7.5%. As can be deduced from the following graph, growth has gone up and come down in every political regime in India, depending on the US/global economic cycle. Though conventional wisdom attributes the last cycle to higher capex, the following chart highlights that this was itself driven by sustained lending rate cuts by the then RBI Governor Bimal Jalan. In order to track lending rate cuts, the analysts advise investors to follow reserve money expansion in India.
Highlighting Latin America’s growth, the analysts note unemployment rates are going to increase in Brazil and Chile. They anticipate the Mexican job market to continue improving slowly and a job-full deceleration in Colombia.