Economic Overview

There is a global unease loose which is yet to be fully answered. Growth has faltered seasonally every year since leaving the 2009 recession, but the momentum loss this year seems to be even more disconcerting than before.

Global markets sold off decidedly this April. Chinese growth disappointed only marginally, as SARB Governor Marcus noted, but the reaction was outsized.

It coincided with poorer US numbers and indications that the European recession is playing out deeper and for longer than advertised, with deep suspicions remaining that Japan will not quite succeed in resurrecting its growth performance.

The US non-farm payroll for April came out above consensus at +165 000, with upward revisions for March of 50 000 and February of 64 000. Taken together this takes the average monthly this year over 200 000 new jobs.

Though countering the growing sense of slowdown, these numbers are nonetheless not good enough to provide escape velocity from slow US growth. And though it disproves any tendency towards new recession and deflation, it will hardly satisfy the Fed.

The Fed went out of its way to single out fiscal policy (that is, Administration and Congress) as the primary reason holding US growth back, without necessarily any prospect of seeing that changed except through attrition.  

Beyond these rich country problems, there is a whole gaggle of EM economies struggling to regain speed, Brazil and India (and yes, South Africa) foremost among them.

At the IMF/World Bank Spring Conference and G20 searching questions were asked about growth. Exceptional Japanese QE stimulus was condoned as an internal policy action aimed at restoring faster GDP growth and 2% inflation.

Every bit of action aimed at getting growth into the system anywhere is being welcomed, even if this gives rise to currency realignments and changing trade and therefore growth fortunes. For if overall world growth could benefit, it is being assumed all will somehow benefit, even if some will do so more than others.

Noteworthy is that despite record policy intervention by central banks, the global growth pace does not seem to be responding. If anything, growth momentum may still be slipping at decimal point level, mainly in Europe and throughout EM space.

This calls into question the efficacy of the extreme policy stimulus of recent years. Yet will we ever know the counterfactual outcome if policy stimulus had not been undertaken on the scale seen, or do we need to revisit the 1930s for that?

For if governments had NOT been pro-cyclically supportive where they have been in recent years, and if central banks had not done so either, and especially of late as the fiscal tide has been receding, what would have happened to markets, assets, global demand, output, jobs?

It has been easy to decry all policy action as decidedly risky. But would doing nothing not have been riskier, in which especially the early 1930s provide a remarkable case study (as were serial depressions in the 19th century, especially the late 1830s and 1870s)?

Japan is only the latest rich country to be greatly gearing up its policy stimulus, monetary and fiscally, in its case attempting to escape two decades of deflation and growth stagnation.

Others have already turned their backs on fiscal stimulus in an attempt to arrest their spiraling debt dynamics.

Fiscal austerity came early to Europe when the 2009 Greek budget revelations started a European sovereign and banking crisis, with Germany insisting that in order to save the Euro Project peripheral countries had to come into line with core northern countries.

In effect, it meant improved governance and heavy fiscal cutbacks as budget deficits had to be reduced and debt spirals arrested and all this without the benefit of a weaker currency, enforcing painful internal devaluations on many non-competitive countries.

This succeeded in cutting budget deficits dramatically these past three years, but also assisted Europe into recession since 2012. The average European budget deficit for 2012 was 3.7% of GDP, varying from nearly zero for Germany to still double-digit for certain peripherals. European national debt averaged 90%.

In the case of the US, the budget deficit peaked at 10% of GDP in 2011, eased to 8.5% in 2012 and is estimated to fall to 4.5% this year as the sequester forced spending cutbacks and restored the payroll tax, with government spending reduced to 2010 levels and the growing economy boosting tax revenues.

These severe policy measures also imposed a major drag effect on US growth in early 2013. GDP grew by 2.5% annualised in 1Q2013, but excluding government the more resilient private sector achieved 3.3% growth, assisted by recovering housing.  

In Europe, the fiscal pro-austerity argument has been negated by an appeal to data, confounding the Reinart-Rogoff 90% debt rule, with many struggling countries now asking that they be given more time to achieve their budget targets, placing less downward pressure on their growth performance.

France and Spain were recently granted another two years to achieve their budget target and Holland one additional year.

Even so, there remains a strong German preference for good governance and internal depreciation for peripheral countries within a one-currency corset, offset with just-in-time country bailouts where needed.

In both the US and Europe the drag effects from fiscal austerity are likely to diminish as budgets come into greater balance. Such fiscal headwind should be felt much less strongly from next year in the US, allowing the underlying private sector resilience to shine through more noticeably, allowing stronger overall growth.

The implication for corporate earnings is likely a major key force behind rising equity markets.

This changing global panorama is giving rise to differentiated central bank actions.

Whereas Bank of Japan only seriously embarked on QE bond buying on an unprecedented scale only from last month, the US Fed has after three major QE rounds these past four years started to consider a tapering of its effort.

With US growth likely to come through more strongly next year, the Fed may want to shift its policy stance to maintaining existing stimulus levels rather than still adding to it. This would mean a gradual stabilising of its balance sheet size rather than keep expanding it, implying a slowing (tapering) of QE.

Even so, this week the FOMC in the face of weakening data maintained a neutral bias, keeping monthly QE at $85bn, but signaling willingness to increase or reduce this depending on how unemployment and inflation develop. These vacillating sentiments were overtaken by the resilient (if still inadequate) non-farm payroll results.

The ECB also hugely increased its balance sheet two years ago when providing trillions of cheap long-term liquidity to banks. In recent months, banks have started to repay such loans, shrinking the ECB balance sheet modestly.

The deeper than expected recession in Europe moved the ECB to cut rates this week and announcing a raft of new attempts to get more lending into the economy, especially regarding SMEs. The Fed for now probably remains committed to its agreed pace of QE ($85bn monthly).

The ECB wants European politicians to do more to reform structurally, improving growth prospects while completing their fiscal consolidation.

Even so, ECB President Draghi has signaled he will act if needed (if growth and inflation warrant it). Market observers take this to mean that more ECB policy easing may lie ahead this year.

The Fed has started to focus on tapering off its QE efforts from later this year into next, though nothing is preordained yet.

Around the world, the introduction of QE caused anxiety as yield-hungry liquidity sought new homes, driving EM currencies stronger and in places adding to domestic asset bubbles.

The eventual withdrawal of QE bond purchases, however, are creating new anxieties in many such countries as any reduced global liquidity could see capital withdrawals from such favoured EM destinations, potentially in a disorderly manner, with new implications for domestic asset markets, currencies, inflation and interest rates.

Such concerns may be overstated, as the bold Japanese QE stimulus may provide cover for the Fed next year to gradually start winding down its QE support without too much of a reduction in global liquidity provided, while the ECB may have to take action to counter Euro strength.

Thus the global monetary playout in coming years may be less draconian than feared. Growth may accelerate a little in places, but nothing extraordinary so far. QE action may start tapering off in places but probably only very gradually even as in other places it is being maintained in strength.

Markets may therefore gain time to adjust gradually rather than abruptly, even if perceptions will be an important part of the driving, and probably anything but slow in reacting to the merest hints of shifting.

Underlying it all is serial progression, from initial crisis events through prolonged repair into eventual recuperation, and this in a desynchronised sequence.

It may all sound too good to be true, but so far that is how things are shaping up.

There is reason to worry about too slow global growth at present and the unknown side effects once policy stimulus is withdrawn, especially for open, domestically underperforming countries such as South Africa.

Even so, growth appears resilient in places (China, US), policy stimulus bold (Japan) or simply supportive (US, China, Europe), with fiscal and monetary withdrawal cautiously staged, probably desynchronised and mostly gradual, with the main focus on restoring growth eventually to potential without disrupting markets or economies in a disorderly way.           

All that is reason to expect a phased transition rather than upheaval and new crises, and it should hopefully limit the downside risks even for exposed, domestically underperforming economies like South Africa.

Cees Bruggemans Consulting Economist                   

Cees@fnb.co.za
Twitter sound bites  @  ceesbruggemans