Global Economic Perspective: August
IN THIS ISSUE:
- US Job Figures Strengthen Prospects for Interest-Rate Hikes
- Global Economy Faces Up to Short-Term Challenges
- Greece an Outlier as Europe Continues to Recover
US Job Figures Strengthen Prospects for Interest-Rate Hikes
Continued improvement in the labor market and overall economic growth mean that the United States continues to move toward tighter monetary policy in the coming months, in our view. Initial estimates showed second-quarter US economic growth coming in at an annual rate of 2.3% (about average for this economic cycle), while the figure for the first quarter was revised upward from -0.2% to 0.6%. There was a further solid nonfarm payroll figure for July, while revisions showed employers added more jobs in May and June than previously estimated. In addition, auto sales have remained healthy, as has the housing sector. Activity in the US services sector (over three-quarters of the US economy) grew at the fastest rate in July since the end of the recession in 2009, according to the Institute for Supply Management (ISM), suggesting that the US economy is on a strong footing and that growth could accelerate in the months ahead.
In late July, the US Federal Reserve (Fed) dropped a subtle hint that it was ready to move on base rates when it shifted away from a previous statement that it would raise rates once it had seen “further improvement” in jobs to one that said it needed to see just “some further improvement.” Then, in early August, the president of the Atlanta Federal Reserve, Dennis Lockhart—considered a centrist among voters on the Federal Open Market Committee—said that only major weakness in data would stop him from backing a short-term rate hike as early as September. The latest nonfarm payroll figures showed little sign of such weakness. The July figure (+215,000) marked the 58th consecutive month of job gains in the US economy, the longest stretch on record. In spite of some weakness earlier this year, monthly nonfarm payroll figures averaged well above 200,000 per month in the first seven months of 2015.
Nonetheless, there are plenty of reasons for the Fed to be cautious. Revisions to gross domestic product (GDP) data going back to 2012 show the current expansionary cycle (which began in the third quarter of 2009) is the weakest since World War II. The growth in wages has not tracked a tightening jobs market, with private-sector wages rising by a modest annual rate of 2.2% in the second quarter, compared with 2.8% in the first. A labor force participation rate that remained a relatively low 62.6% in July and evidence that a large part of the improvement in payrolls was due to part-time jobs rather than full-time ones point to continued slack in the workforce. Additionally, the ISM’s monthly manufacturing survey, while still growing, showed a slowdown in the rate of expansion in July, and productivity growth is still in the doldrums. Nor can the lack of inflation be ignored: Core personal consumption expenditures (excluding food and energy), a gauge the Fed pays particular attention to, has remained stubbornly low in recent years and rose at an annualized rate of just 1.3% in June, well below the central bank’s objective of around 2% core inflation.
The severe drop in commodity prices, while positive for the economy overall, has proved to be a drag on overall corporate investment, and second-quarter earnings reports revealed a slump in revenues for S&P 500 companies due largely to the performance of the energy sector. Nor are currency movements helping. After stalling, the US dollar has begun to climb again, hurting exports and adding to a growing trade deficit. An economic slowdown in China may also be starting to affect large US exporters.
In short, we believe sound headline job creation figures point to interest-rate increases by a Fed that would like to begin to “normalize” monetary policy when possible. The US economy is no longer in the emergency room, as it was in December 2008, when short-term rates fell to their current level of “at or close to zero” and where they have remained ever since. Sluggish wages and an uncertain global picture may not be enough to stay the Fed’s hand in circumstances in which the US unemployment level has fallen close to 5%. At the same time, Fed Chair Janet Yellen has been cautious in her comments about interest-rate rises, conscious that growth remains modest and anxious to minimize market disruption. It therefore looks likely that rates will be increased gradually and in small steps. And indeed, Fed officials have been at pains to point out that the path for rates in the medium and long term is more important than the exact timing of the first base-rate hike in nine years.
Global Economy Faces Up to Short-Term Challenges
As the Fed appears set to lift official borrowing rates for the first time in nearly a decade, currencies of emerging markets and commodity exporters have come under increasing pressure, exacerbated by the slowdown in China. In the first seven months of 2015, the Brazilian real lost almost 30% against the US dollar, while the Australian and Canadian dollars and the Chilean peso each lost over 10%. The disaffection for emerging markets in particular can be seen in equity indexes, with the MSCI Emerging Markets Index falling by over 13% in the first seven months of 2015, and emerging-market funds experiencing significant outflows.
And while Europe and the United States seem to have steadied their economies, the outlook for the global economy at large is only fair to middling. On July 9, the International Monetary Fund (IMF) cut its forecast for 2015 global growth from 3.5% to 3.3%. Demand indicators pointing to sluggish activity in a number of large emerging-market economies underscore this slowdown. In volume and value terms, global trade has been falling, while the JP Morgan Global Manufacturing PMI (purchasing managers index) has sagged in recent months.
In many countries, central banks have been trying to ease economic conditions by lowering policy rates, but they have been constrained by the need to defend the local currency against a rising US dollar. Indeed, currency pressures have recently forced central banks in South Africa and Brazil to hike rates in spite of economic fragility. Yet we are not convinced there will be a repeat of the Asian crisis of 1997–1998, or even of the “taper tantrum” of 2013, when the Fed first indicated it would begin reducing its bond-buying program. Renewed attention is rightly being paid to the buildup in leverage in a number of countries in recent years, often dollar-denominated, but that leverage has tended to be concentrated among corporations rather than sovereigns. Most of the dollar pegs that caused problems in the past have given way to floating currencies, which tend to allow for smoother adjustments to changing circumstances. And while the United States is likely to start tightening policy rates, the global economy should benefit from continued policy easing in China, Japan and the eurozone.
Improved US and European economies are good news for the rest of the world, as are stabilization in China and the commitment of the authorities there to foster domestic