Economic Outlook April 2014

Global economy continues to regain momentum, but sinkholes might lurk in the reeds.

The global economy is gradually reaching firmer ground, but this trend is marked by temporary setbacks and massive regional differences. The recovery in the United States lost momentum in the first quarter, when extreme weather conditions hampered economic activity and GDP for Q1 fell to a 0.1% annual rate. This was well below expectations of some 1.3% growth. However, based on strong indicators this spring, we expect a clear rebound in the second quarter. SEB has recently adjusted its full-year 2014 GDP growth forecast downward from 3.3% (set in February) to 2.6%. Japan’s economic reform program faces major challenges when it comes to permanent ending deflation and carrying out structural reforms. The Tankan survey fell in April from a high level in Q1, reflecting greater uncertainty about April’s increase in consumption taxes. In the euro zone, the recession seems to be over and financial worries have gradually eased. Unemployment and government debt have also stabilized, but at worryingly high levels.

Completely as expected, the US Federal Reserve (Fed) upgraded its economic outlook and reduced its stimulative monthly bond purchases by USD 10 billion to USD 45 billion. The central bank thus decided to ignore the weak GDP growth figure from the first quarter. Due to cold weather, the US economy expanded by only an annualized 0.1%, compared with market expectations of 1.1%. The Bureau of Labor Statistics reported strong job data in April and unemployment fell to 6%, its lowest since the Lehman Brothers crash in September 2008. Together with a positive outlook from purchasing managers in the manufacturing sector, these labour market figures confirmed the picture of a steady US recovery.

Furthermore, Fed in its latest minutes of its monetary policy meeting made it clear that “the Fed’s first key interest rate hike may come about six months after the end of its bond purchase program (QE3)”. Instead of a 6.5% unemployment threshold, the Fed will look at a broader set of data that may justify a rate hike. We still expect that rates will stay untouched (and low) for a foreseeable future and that an upswing should not be expected before well into 2015. However, the Fed projects that financial markets will gradually turn its focus away from the tapering and start to incorporate money-market rate hikes during 2015.

As such, improved corporate earnings and satisfactory economic indicators is a must to keep up the pace in the US stock market and give valuation support when money rates start heading north.

Europe continues to show positive signs of a recovery. No doubt that the tide has turned in the broader southern European economy. Spain and Italy again show positive growth in GDP, consume and investments. However, most of the European Mediterranean economies are still fragile and heavily debt loaded and we see very few tools to avoid serious set-backs of the global economy. We are moderate optimistic for a European recovery as such, but expect low growth rates due to highly indebted countries in combination with slowish labour markets with few signs of needed reduction in unemployment rates. This is absolutely essential to have consumer confidence and consumer spending back on a positive track.

Despite continued low increases in the euro zone consumer price index (CPI) and falling inflation expectations, the ECB left its key interest rate unchanged as expected. However, in April the ECB reported that it had test-simulated what impact EUR 1 trillion in government bond purchases might have. The markets quickly traded down euro zone yields based on this information. Sentiment indicators for Euro-land have kept improving this spring. Purchasing managers’ indices (PMIs) and the European Commission’s Economic Sentiment Indicator (ESI) show a consistent picture of the situation. While manufacturing PMI fell a bit early in 2014, it remains well above the growth threshold of 50. Having diverged around the end of 2013 the PMIs in the four biggest countries (Germany, France, Spain and Italy) have converged at around 53 in April. France is lagging behind; the index fell to 51.2 in April. Of the crisis-hit countries, Greece is somewhat below the others but reached above 50 in April.

The Ukraine/Russian conflict continued to create human, economic and political unrest during April and the crisis escalated throughout the month. Ukraine is now on the brink of civil war. Meanwhile tensions between Russia and leading Western countries have worsened. The acute security situation appears likely to last for some time. Russia’s already strained relations with the EU and US have deteriorated radically. During the spring, SEB has adjusted its economic forecasts for the region downward. Ukraine is now entering a deep recession, while the Russian economy will stagnate this year. The political crisis is exacerbating an already weak economic situation largely caused by structural problems. Nearby countries that trade heavily with Russia, such as Finland and the Baltic countries, are clearly affected. Our main global scenario is based on the assumption that a large-scale trade war between Russia and the EU/US can be avoided and that there will be no major disruptions in Russian energy deliveries to Western Europe. The general effects on the world economy will thus be relatively minor. However, economic consequences from this conflict are somewhat out in the blue due to the relative short duration of the conflict this far.

Anyway, underpinnings of the euro zone's nascent recovery are still fragile and there is significant dependence on Russia's natural gas deliveries. As mentioned above, the euro-zone began a broad economic recovery in the second half of 2013 or just earlier this year. The improvement has been clearest in the central region, which has benefited mainly from faster growth in Germany and the stabilization of the euro zone economy and banking system. The recovery is expected to continue at a steady pace and become more broad-based, but the industry, consumers and power plants are in general dependent on a steady stream of Russian gas into Europe. As such, disturbance in deliveries might be a catalyst for slower industrial activity and change in consumer spending pattern due to an (massive) increase in power/gas costs for the broader European market.

Emerging Asia is still growing faster than other parts of the world economy, but the pace of expansion is much slower than before the financial crisis. China’s economic deceleration continued in the first quarter, hampering growth in the rest of the region. Since this deceleration is primarily driven by weaker capital spending, commodity-exporting countries such as Indonesia are affected the most. In recent years, growth has largely been driven by domestic demand that is stimulated by soft monetary policies, rapid credit expansion and strong labour markets, but in many places credit growth is unsustainably fast. In Singapore and Malaysia, lending has already begun to decelerate, but only in 2015 do we expect more widespread monetary policy tightening in the region. Yet slowing domestic demand in some economies will be offset by stronger external demand, mainly from the US. Most indicators point to continued overall gradual recovery in growth in 2014-2015, except that China is expected to keep slowing. China’s economic deceleration late in 2013 continued early in 2014. First quarter GDP growth slowed to 7.4% year-on-year, down from 7.7% in the fourth quarter. Purchasing managers’ indices have been very weak in recent months. The official PMI is slightly above the growth threshold of 50, while Markit’s index, which includes a larger element of small companies, has been below 50 since January. Our conclusion is that China PMI hints of stabilization, though not a turn.

Japan seems to face short-term deceleration due to the recent tax hike. Abenomics – the policy package launched by Prime Minister Shinzo Abe in 2012 – gave the Japanese economy a jolt of energy, followed by a slowdown last autumn once the effects of earlier yen depreciation and fiscal stimulus measures faded. According to the quarterly Tankan survey, companies have downgraded their outlook for capital spending and forward-looking business confidence fell from a high level in the first quarter, reflecting greater uncertainty about April’s increase in consumption tax from 5% to 8%. But the resulting fiscal tightening is being offset by infrastructure investments and corporate tax relief equivalent to 1% of GDP from the October supplementary budget. On the other hand, this means Japan is falling behind schedule in reducing its budget deficits. Japan continues to stand out as a question mark whether it will be a drag or a pull on global economic data for the remaining 2014 and into 2015.  Mr Abe and Bank of Japan will have to announce expanded stimulus measures as well as structural reforms to sustainably boost growth.  We expect further news in this relation within the coming months.

Overall, our message is that the global economy is on a growth track, but it’s fragile due to different geo-political and economic issues. The political turbulence in Ukraine adds on to a turbulent geo-political situation in many other regions. The European recovery is still in an early phase and changes in sentiment will probably widen credit-spreads and lift interest rates in the most vulnerable Euro-economies. If so, the expectations of a marginal positive growth might turn sour and again hit a negative growth momentum. We find the low interest rate regime as being supportive for the growth expectations. The global economy is highly dependent on fiscal stimulus in major economies and that the world trade is not hurt by conflict related disturbance due to political decisions or from a lack of trust in the future amongst capital spenders and consumers. 

By Lars-Henrik Røren, Head of Investment Strategy