The latest view on the economy
by Douglas Porter, CFA, Chief Economist
The following is courtesy BMO Capital Markets and is posted with permission.
In a wild week for financial markets, the challenge was isolating the main cause of the growing angst. Broad concerns about the global economy are clearly the driver, but we have to be more specific than that, since 2014 marks the third year in a row of sub-par world growth, and equities had previously glided through those choppy waters. We can point to four trigger factors for the recent draw-down in markets, but at least three of them look to be more symptoms rather than causes of the softening global growth backdrop. In rising order of importance, here is how we would assess this week’s market disruptors:
- IMF marks down global growth outlook: Ahead of its fall meetings in
Washington, the IMF released its latest forecasts, and sliced the world growth
call to 3.3% this year (from 3.4%) and to 3.8% in 2015 (from 4.0%). No to question another forecaster’s chops (people in glass houses and all that), but
let’s just say that relying on the IMF for leading edge views is like reading yesterday’s newspaper for today’s tweet. That is, this growth trim has long been baked in by market forecasters—if anything, we would be below their call for both years (3.2% and 3.5%), and we are far from the bearish end of the
spectrum. Given recent developments, their new 3.8% call for next year looks positively perky.
- Concerns over a rising U.S. dollar: After a three-month, non-stop rally, the relentless strength in the U.S. dollar and some of its potential downsides suddenly burst onto the market radar this week. Some warned that the rising greenback would “imperil” corporate profits, while the dovish FOMC Minutes pointed to the growth and inflation dampening impact of the strong currency. Not to completely dismiss these concerns, but we would argue that the fears are overblown. First, the move in the dollar remains mild by historical standards. Its 9% y/y rise is far from extraordinary, and pales next to the massive advances in the early 1980s and late 1990s. Second, the U.S. is simply not overly dependent on exports to drive growth: it can go it alone. Third, the rising U.S. dollar takes pressure off many beleaguered or struggling economies, including the manufacturing heartland of Canada, as well as many emerging markets. After all, this move in the big dollar is “currency wars” in reverse.
- Sagging oil prices: Perhaps the most notable move of the many moving parts in recent weeks is the deep drop in oil prices. Brent fell below US$90 on Friday morning, bringing it more than 20% below its June levels and thus into full-on bear market territory, and WTI has largely mirrored the move (dropping to $85). While this is bad news indeed for the hottest regions of North America (North Dakota, Texas, Alberta, et al), Russia, and much of OPEC, it’s a quiet windfall for global consumers. True, the industrialized world does not need yet another source of disinflation at this point, but the drop in energy prices acts as a tax cut for consumers by giving a small bump to real disposable income. In other words, lower oil prices are a by product of weaker global growth (and rising oil production) and act as a nice cushion for much of the world.
- Deepening concerns over Europe, specifically Germany: Markets had been mildly unsettled in recent weeks over the persistent growth woes in Italy and France, but a slew of deeply disappointing results in previously unscathed Germany landed the most telling blow. A run of uber-declines in German factory orders (-5.7%), industrial production (-4.0%) and exports (-5.8%) in August point squarely to a second straight quarter of declining GDP in Europe’s biggest economy. Not helping matters was a public squabble between the ECB’s Draghi, who said that monetary policy needed help to revive growth, and German Finance Minister Schaeuble, who believes reforms and deficit reduction are the best options. While Angela Merkel gave hints that spending policy may be softened slightly in Germany, the die may already be cast amid sagging business confidence across the continent.
Larded on top of these growing economic concerns are a witches’ brew of geopolitical risks, led by the four horsemen of ISIS, Ebola, Ukraine and Hong Kong. And, of course, rumbling away quietly in the background is the impending end to QE3, which had helped lift the S&P 500 by 37% since it was unleashed just a little more than two years ago. Notably, amid the deepening financial market trauma and worries over growth abroad, the economic news from North America remains positive. Following hard on the heels of the solid U.S. payroll report last week, Canada delivered shockingly strong jobs figures for September, and an upbeat quarterly Business Outlook Survey from the BoC. Meantime, final budget deficit tallies for FY13/14 for both Ottawa ($5.2 billion, or 0.3% of GDP) and Washington ($486 billion, or 2.8% of GDP) came in below expectations, with at least the former already shifting to modest tax relief measures in response. The test in the months ahead is whether these improving economic trends can hold up amid the waves of bad news from overseas—we believe they can, but markets are clearly less confident, and are sending a loud warning shot