Global Growth Slowdown Persists
Volatility + Uncertainty ≠ Stronger Global Growth
The global economy continues to struggle, with China’s slowdown, the downward bias in commodity prices, and the renewed increase in financial market turbulence risking further weakness. There are not enough growth engines around the world. Only the U.S., the U.K. and India can be considered relative outperformers, countries which appear to be the most resilient and have the potential to generate stronger, and importantly, more sustainable activity. In contrast, most nations and regions are reporting moderate output growth. And a number of large nations, including Brazil, Russia and Venezuela, are still mired in recession.
Financial market volatility around the world has increased dramatically in recent weeks. The large and synchronized sell-off in global stock markets, followed by only a partial rebound, continues to grind lower and highlights a downgraded assessment of economic conditions and corporate earnings.
The increase in risk aversion has put added downward pressure on already low sovereign bond yields throughout the advanced economies, and even in the U.S. where strengthening employment and output growth threaten to boost wages and inflation. Around the world investor confidence is being challenged.
China’s continuing underperformance is highlighted by the slump in manufacturing and two-way trade. Commodity prices remain under pressure. Many international currencies are being marked lower vis-à-vis the U.S. dollar, a trend reinforced by the Renminbi’s mid-August devaluation. Concerns surrounding debt sustainability in many overseas jurisdictions have resurfaced, especially with regard to U.S. dollar-denominated liabilities.
Geopolitical issues remain ever-present. And there is the uncertainty surrounding the extent of rate hikes once the U.S. Federal Reserve begins to normalize ultra-low borrowing costs, possibly later this year.
In this environment, business investment — less than buoyant to begin with internationally — is at risk of a further slowdown in response to the increased economic uncertainty, the absence of a discernible pick-up in global demand and trade, and the forthcoming production adjustment s needed to redress overcapacity in some sectors and particularly in the commodity-related areas.
Accordingly, prospects for global growth are likely to remain on the softer side for the time being. The biggest downside risks are in the resource-sensitive regions. Many emerging market and developing nations — ranging from the Asia-Pacific region to Latin America — are being negatively affected by the combination of the slowdown in China, the decline in commodity prices, persistent U.S. dollar strength, and the intensifying weakness in currency and financial markets.
More advanced economies — including Canada, Mexico and Australia — are also being squeezed by the investment, output and employment adjustments needed to rebalance operating conditions to the new reality of oversupply, lower prices and reduced earnings.
Geopolitical events and recurring volatility aside, underlying fundamentals suggest that crude oil prices will likely remain on the weaker side for longer. The global market remains significantly oversupplied, but other factors are also at play, including the strong U.S. dollar and questions over prospective demand in a slower-growth environment.
Although this situation is not sustainable over the longer term given the generally higher production costs in most producing regions outside of the Middle East, the needed adjustments to restore market balance will take longer to materialize since OPEC nations are continuing to boost oil output, while U.S. shale production remains quite resilient and worldwide inventories are very large.
Moderate growth and weak prices for many key commodities besides oil are reinforcing the likelihood of a more prolonged period of very low overall inflation. Increasingly, more and more policymakers around the world are favoring easier credit conditions and weaker domestic currencies to provide some relief. The recent monetary easing by China, in addition to prior initiatives aimed at supporting slumping equity markets and a bias towards a weaker Renminbi, highlights the concern over deteriorating economic prospects.
The amount of fiscal stimulus has been more modest, though many jurisdictions, including Canada and most countries within the Pacific Alliance, are bolstering infrastructure spending to help boost flagging demand. The challenging conditions around the world do pose some risk to the U.S. outlook. The softer global environment coupled with persistent U.S. dollar strength has the potential to weigh on U.S. growth.
Weaker exports and stronger imports are already resulting in a reduction in net trade, while profits from foreign earnings will be increasingly pressured. Business investment outside of the tech sector will also be constrained, primarily by the softness in energy-related expenditures, but also in agriculture and other sectors affected by the decline in commodity prices.
Nevertheless, the U.S. expansion appears to be on a more sustainable growth trajectory, with the latest upward revision to second quarter real GDP highlighting the solid support provided by domestic spending. Consumer and housing-related activity are benefiting from continuing and large job gains, improved household balance sheets, comparatively low mortgage rates, and even lower prices at the pump.
Orders and investments in the non-resource sectors are gradually improving again. Data for the third quarter are only preliminary, though early indications suggest that American consumers are still confident and willing to spend on ‘big-ticket’ items — cars, homes, and home improvements — and increasingly on services, particularly restaurants and health care.
The Fed is poised to raise short-term interest rates, with expectations being deferred to December. But the timing and extent of prospective rate hikes will depend upon the strength of the U.S. expansion and ‘core’ inflation, and the potential for any spillover from the volatile financial market and economic conditions around the world.
The composition of the Fed’s portfolio of U.S. Treasury and mortgage-backed securities, together with potential asset allocation shifts from core creditors such as China and Japan, will be an important driver of long-term yields over the next year.
Economies which are cyclically aligned to the U.S. business cycle, ranging from Canada to Mexico and the Caribbean, should benefit from rising U.S. demand and more competitive currencies. Transportation equipment, machinery, and building materials industries, as well as tourism, should benefit. Household spending in Canada should remain relatively resilient, bolstered by exceptionally low borrowing costs and continuing gains in the large and diverse service sector.
For Canada’s non-resource industries, gains have been more uneven than expected, but output growth in Ontario, British Columbia and Manitoba this year and next is still expected to be reasonably firm. However, business investment, particularly in the large resource-dominated sectors and regions, will be further constrained this year and next.
The contraction in Alberta this year is now steeper, and the 2016 rebound more muted, reflecting the broadening impact of a more hesitant recovery in oil & gas investment. Helping to sustain Canada’s growth this year and next are elevated infrastructure commitments from Ottawa and the majority of the Provinces.
Moreover, while we expect the Bank of Canada will remain on hold through 2016 with core inflation currently above 2%, there is an increasing risk of an even more accommodative policy if the country’s economic underperformance persists.
The current softness in the global economy is expected to give way to renewed economic traction as the drag from structural adjustments and financial market instability abates. Considerable pent-up demand in the U.S. should underpin steady consumer spending and housing-related gains. Increasing monetary and fiscal stimulus should help stabilize conditions in China.
Persistently low borrowing costs and low oil prices remain supportive of improved economic performances internationally. And in contrast to the Great Recession, many banks around the world are much better capitalized and capable of financing increased activity.
We have trimmed our global growth forecast for this year to 3.0%, with downward adjustments to most countries outside of the U.S. and the U.K. Incoming economic indicators suggest that the euro zone recovery remains on track; however, the growth outlook has been tempered by months of political uncertainty in Greece and recent turmoil in China. We have edged down our euro zone growth forecast to 1.3% in 2015 and 1.6% in 2016 (from 1.5% and 1.7%, respectively).
Similarly, we have lowered our estimate for French real GDP growth to 1.0% in 2015 and 1.3% in 2016 (from 1.1% and 1.4%) due to the moderation in private-sector activity. The inflation outlook in the euro zone’s four largest economies has also softened, leading us to lower our year-end euro zone inflation forecast to 0.4% this year and 1.2% in 2016.
We have revised our Chinese real GDP growth forecast downwards on the back of ongoing evidence of a slowdown portrayed by subdued high frequency indicators in industrial production, retail sales and exports. We now expect the country’s output to grow by 6.8% this year (still in line with the official target of “around 7%”) and 6.4% in 2016. The August bombings in Bangkok will slow the Thai economic recovery as the tourism industry has been one of the key drivers of growth. Accordingly, we have lowered Thailand’s real GDP growth forecast to 3.0% for this year and to 3.6% for 2016. We have also incorporated an additional interest rate cut into our forecast.
We have revised lower our Indian real GDP growth forecasts following a soft Q2 result, and now expect the economy to advance by 7.3% and 7.6% in 2015 and 2016, respectively. Brazil’s contraction in real GDP has been deepened to 2.5% in 2015, with the recession persisting into next year.
Accordingly, we have weakened the profile for the Brazilian real. Persistently weak commodity prices coupled with fragile domestic economic conditions prompted a downward revision to our real GDP growth forecast for Chile over the next two years.
The Colombian economy continues to adjust to a weaker currency environment driven by a sharp decline in energy export receipts. Peso (COP) depreciation has given rise to above-target inflation. The economy is expected to expand by 2.8% this year, with risks tilted to the downside.
We have lowered exchange rate forecasts in all floating Latin American currencies through the end of 2016.