Early signs of normalisation in global growth

Cyclical surge has slowed down but the US and China seem fine … for now


For many months, the Fulcrum global nowcasts have painted an extremely consistent picture of strong – and recently rising – cyclical growth, permeating all corners of the world. This regime of strong global expansion in real output has been the dominant driver of asset returns for the past two years.

The latest monthly report on the nowcasts is interesting because it suggests that the momentum of the boom may be beginning to fade a little. But so far the evidence of weakness is geographically patchy and it does not suggest that the 18-month period of above-trend global growth has ended.

A pause for breath may be a favourable development for the eventual sustainability of the expansion, since it reduces the risk that a runaway cyclical boom will blow the lid off world inflation. The nowcast models have been anticipating some mean reversion in global growth during 2018, though it may be happening earlier than expected by the models.

Return from the stratosphere

JPMorgan economists refer to a “return from the stratosphere”, and that seems the right assessment for now. The growth rate in manufactured goods sectors late in 2017 was unsustainable, and it is now clearly slowing as financial conditions tighten, oil price increases damp real disposable income, the boost from inventories slackens, and global capex come slightly off the boil.

The annualised growth rate in global industrial production was 5.5 per cent in the fourth quarter of 2017, but it now seems to have dropped to the region of 3-4 per cent, and some further decline seems likely in coming months as excess inventories are run down.

However, a more sinister downturn in the global economy, encompassing the service sectors, still seems improbable. While monetary policy is set to tighten in the US, it is doing so from abnormally accommodative readings. Furthermore, the US fiscal stimulus is looking likely to be larger than first anticipated, and China seems to be sailing serenely through the Xi Jinping policy reforms.

Asian trade growth is still doing well, though it is vulnerable to any extension of President Donald Trump’s trade controls, which have obviously become a major risk. So far, the sectors covered by the US trade tariffs cover only 2 per cent of global goods trade, representing a negligible percentage of global GDP. Furthermore, the early political response about retaliation from China seems to be encouraging. Hopefully, the threat of a trade war can be contained.

As a result of the normalisation of growth in the goods sectors, the nowcast for global activity has fallen to a reading of 4.1 per cent (using PPP exchange rates to calculate country weights), down about half a point from the average growth rate recorded since last autumn. This still leaves the growth rate about half a point above the long-term trend, suggesting that slack in the world economy is still being absorbed at a meaningful rate.

World estimate

Advanced economies still growing above trend

In the 2017 cyclical surge, the advanced economies (AE) were growing at about 3.5 per cent, about twice the long-run underlying rate (which, incidentally, has shown no signs of improvement during the boom). This situation was never likely to prove sustainable and, sure enough, the AE nowcast has dropped to a more realistic 2.5-3.0 per cent range.

Data surprises have turned neutral in recent weeks in both the US and the eurozone, after a long period in which they were strongly positive, leading to continuous upgrades in consensus GDP forecasts for 2018. These upgrades will probably now start to level off, taking some of the momentum out of the “expansion regime” that has been dominating global financial markets since mid 2016.

“If there is a problem, it is in Germany and the rest of the eurozone, which have been affected by the strength of the euro and political uncertainties surrounding German corporate tax.”

Among the AEs, the decline in activity growth has been negligible in the US, which is still running at about 3.5 per cent, confirming Jay Powell’s assessment that “headwinds may be turning into tailwinds”. US activity growth is estimated to be running at about 3.5 per cent, only 0.5 points down from recent peaks. However, activity growth in the eurozone and Japan are both reported to have dropped by about 1.5 percentage points since late 2017, reaching 2.0 and 1.3 per cent respectively.

The decline in Japan is driven mainly by an extremely bad monthly figure for industrial production in February, which may be partly due to the impact of Chinese new year on demand for Japanese products.

If there is a problem area, it is Germany and the rest of the eurozone, which seem to have slowed significantly since the turn of the year.

In Germany, the Ifo and PMI business surveys for February both fell by a couple of points from recent highs, retail sales have been weaker than expected and labour market data (such as unfilled vacancies) have been revised downwards. The German nowcast has dropped to only about 2 per cent, about half recent growth rates, and other eurozone nowcasts have also eased.

It is possible that the strength of the euro, along with political uncertainties surrounding German corporate and household tax policy, have been to blame. This is an unexpected development that needs careful watching in coming months.

Estimate of Underlying Activity Growth

China still barrelling along

Swings in global activity in recent years have often been driven by the mini cycle in China, so the signs of a global slowdown raise questions about the strength of Chinese economic activity in the context of the policy reforms being introduced by President Xi Jinping. Although there have been some wobbles in monthly series, partly due to the introduction of tougher pollution controls, Chinese new year makes these monthly readings unreliable.

The nowcast, which should be able to smooth out these seasonal variations, has shown no sign of a slowdown in activity growth below 6 per cent – something that bodes well for the future of the global expansion.

China estimate


Source: This note is based on material which appeared in an article by Gavyn Davies published in the Financial Times on 4 March 2018.
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