It’s Not All Bad – The US is Back On Top
Let’s start on a positive note – the only major economy to have their forecasts upgraded in the past year was the United States. In 2015, Fathom expects GDP growth of 4.1 percent; if delivered this would be the best annual rate in more than a decade. Why? Against the backdrop of cheaper oil and a tighter labor market, private consumption expanded by 4.3 percent in the final quarter of 2014, its fastest rate of growth since the onset of the Global Financial Crisis. The labor market has enjoyed its longest run of net job creation since payroll data was first collected in 1939; combined with underlying productivity growth, this will start to put upward pressure on national incomes. Core CPI inflation is expected to hit the Federal Reserve’s national tolerance rate of two percent in 2015, which should allow the Fed to begin hiking interest rates by the third quarter of this year. A strong dollar is a double edged sword. As current earnings announcements are showing, profits repatriated back to the US are affected by the translation effect.
Weaker Demand in China is Slashing Global Commodity Prices
Weakening demand for oil in China, combined with a dramatic increase in US production and Saudi Arabia’s refusal to cut its own production are major culprits for the halving of the oil price since mid-2014. If Saudi Arabia is the ‘swing producer’ in the market, then China is the ‘swing consumer.’ At the time of China’s accession into the World Trade Organization in 2001, the positive shocks to Chinese oil demand drove prices from around $20 per barrel in the 2000s to more than $140 per barrel by mid-2008. Negative shocks to Chinese oil demand, such as the 20 percent drop in imports since January 2014, are now reversing the trend. It is the synchronized nature of the fall in commodity prices central to China’s production processes that indicates the fall in oil prices has as much to do with weaker demand as it does strong supply.
China’s Slowing Growth Will Cause Global Deflation
The world’s fastest growing major economy, whose growth rates have averaged ten percent over the past 30 years, is now experiencing its slowest growth for 24 years at 7.4 percent. A monetary contraction needs a monetary response, and the most likely route for policymakers will be to let go of the dollar peg. This would have the potential to export a substantial amount of deflation around the world. Fathom forecasts that the Reminibi would fall by 25 percent in trade-weighted terms, which would push global inflation down to just 1.7 percent this year – the lowest rate since at least the 1960s.
Further Deflation Will Test the European Central Bank’s Reserve
By January 2015, 12 of the 19 members were affected by deflation. This has forced the European Central Bank to announce a purchase program for a mix of private and public sector debt at a rate of €60 billion (US$67.8 billion) per month starting in March 2015. The Expanded Asset Purchase Program (EAPP) is intended to last until September 2016, suggesting a total size of €1.1 trillion (US$1.24 trillion). By adopting the policy, the ECB is sending a clear message to markets that it is determined to bring inflation back up to two percent. The further weakening of the Euro is expected, which has already fallen by 14 percent against the dollar over the past year and has reached its lowest level for a decade. Europe’s QE program is different to those adopted by the Federal Reserve and the Bank of England at the height of the Global Financial Crisis, and has more in common with that of the Bank of Japan. The main concern is that like Japan in the early 2000s, the ECB is introducing the policy far too late.
China, the world’s second largest economy, missed its official growth target for the first time this century. This will have profound implications for the global economy. Cheaper commodity prices have not been the ‘shot in the arm for global growth’ as previously expected, and deflationary pressures will continue to test the resolve of Quantitative Easing programs in Europe and Japan. One notable exception is the United States, where the International Monetary Fund has upgraded their growth forecast to 3.6 percent this year. Their global outlook is not so optimistic, with growth forecast to decline to 3.5 percent in 2015.