As we are getting to the mid-year point of 2014, and before I take a (holiday) break from writing my weekly Big Picture, it is a good time to review what has happened so far this year and what that might mean for the rest of the year. I am a fairly optimistic person by nature and we have been on the optimistic side of the debate about the global economy for some time. I am writing this commentary just after the Dutch soccer team beat Spain 5-1. This was so unexpected (the adrenaline is still rushing through my veins) that I am afraid it might colour my judgement on the economy a little. I hope you can forgive my euphoria this time. But I actually think that the second half of the year will be like the second half of Holland - Spain.
I think the global economy in second half of the year will be like the second half of Holland (5)- Spain (1)
Han de Jong Chief Economist
A looming threat
Before I surrender to euphoria, let me also mention that developments in the Middle East, and in particular in Iraq are a threat to the outlook for the global economy and for financial markets. If the turmoil intensifies sentiment will be hit. In addition, a sharp rise in oil prices, which cannot be rules out if turmoil persists always has the potential to derail a recovery in western economies.
At the start of the year, our view on the global economy was a relatively optimistic one. The deleveraging process in the US private sector seemed largely complete, while is was progressing in Europe. Stress in the financial system, which had pushed Europe into a double dip recession in 2012/2013, had eased a lot and austerity was clearly past its peak. The abating headwinds were going to provide room for stronger economic growth, we thought.
Six months later, we must concede that global growth in the first half was below our expectations. We were not the only ones disappointed with the GDP numbers in various countries. Only last week, the World Bank lowered its global growth forecast for the year. This was, however, largely a backward looking revision. What I mean is that the World Bank economists put the weak numbers for the first quarter into their calculations. When you do that, the growth forecast for the year falls, but that does not really mean that you have become more negative about the immediate outlook.
The main reason the global economy performed worse than hoped for is that it hit several, unrelated potholes. Severe weather in the US led to a relatively sharp contraction of that country's economy. Japan also had some bad weather early in the year and then had to deal with the 2% increase in the sales tax. This tax hike was obviously not unexpected, but it led to some deceleration of activity growth in the second quarter. Then there were concerns over China. Its economy kept slowing and the policymakers tried to fight that by taking a series of targeted, relatively small measures. In the past, they might have taken more substantive action. The result was an economy that seemed to continue losing momentum. Europe did not hit a particular pothole, but the continued strong euro and concern over the banks did not do sentiment any favours either. On top of all this, the tension over Ukraine also affected confidence badly.
1-1 at half time, 5-1 at full time
You will hopefully forgive me for drawing a comparison between the global economy and last Friday's football match. My view is that what happened in the Spain - Holland match can be compared to the likely path for the global economy. The good news is that the underlying forces that made us optimistic at the start of the year are still there, while the factors that led to disappointments in the first half are disappearing. Having been held back in the first half of the year, it is now also time for some positive pay back. In addition, the ECB's actions have given some additional impetus as they continue to drive down borrowing costs in the peripheral countries.
Recent data pointing to 5-1
Last week's data is consistent with our buoyant outlook. Eurostat's release of industrial production data for the EU in April was stronger than expected, helped, it must be said, by a jump in energy production. Output rose by 0.8% mom in April, after March' decline of 0.4%. What is happening in Europe can perhaps best be described by looking at individual countries. The message is clear. The countries that went through the most pain in recent years are now leading the pack. Industrial production growth in Greece, Ireland, Portugal and Spain rose (mom) by 0.9%, 2.1%, 6.7% and 1.7%, respectively. The numbers for the year-on-year comparison stand at: -2.4%, +15.0%, +5.8% and +4.7%. On the downside, countries that were not forced into painful policy adjustments are lagging behind. Output in France and Italy rose by 0.1% and 0.7% mom respectively in April. France in particular is struggling. Its production level was 1.8% lower than a year earlier, while Italy's was up 1.6%. The Banque de France business confidence gauge weakened again in May.
The Q1 employment data was also positive. Employment in the eurozone expanded by 0.1% compared to Q4 last year, the second consecutive improvement (however small). On a yoy basis, employment was up 0.2%, the first rise since 2011 and only the fifth positive number since 2008.
Last week's US data was also generally encouraging. Confidence among small businesses, the backbone of the economy, rose in May to its highest level since 2007. While this is based on a small survey, I see this as a sign that the basis for the economic recovery is getting much more solid. Retail sales were on the weak side in May, but the revisions to the April data were strongly positive. The annualised growth rate of total retail sales during the last three months now actually stands at 9.2%. The labour market continues to improve. Jobless claims were a little higher in the most recent week, but the detail of the small-business confidence index showed stronger demand for workers and the report on job openings (the so-called JOLTS report) also jumped, reaching its highest level since 2007.
Japan's economic data last week seems to confirm that the economy is coping reasonably well with the aftermath of the tax hike in April. Particularly encouraging was the upward revision of investment spending in the Q1 GDP revision. Business spending is now thought to have risen by 7.6% qoq annualised, up from the initially reported 4.9%. In addition, the outlook component of the 'economy watchers survey' rose in May, building on April's strong rebound.
China's economy appears to have turned the corner of slowdown. Retail sales, industrial production and money supply data all improved in May.
From 5-1 to winning the World Cup
While I believe the immediate outlook for the global economy is very positive, that does not mean there are no problems, worries or challenges ahead. The Dutch football team could easily still disappoint and the global recovery may also come under pressure. As I mentioned above, escalation of hostilities in Iraq could have very negative effects. The main economic concern on my radar screen is monetary policy. Central banks have adopted an unprecedentedly easy stance and at some stage the process of normalisation must start. Bank of England governor Mark Carney fired a warning shot last week when he said that policy tightening may start earlier than the market is pencilling in. Gilt yields and sterling moved higher, though to a modest degree. Is that the market reaction we should expect or will markets respond more strongly when more central bankers start to talk like that? And what will that do to risky assets? The position of the US is particularly interesting and important to financial markets. US unemployment has fallen a lot and inflation is rising. In fact, the Fed is not far away from hitting both targets of its dual mandate. It is probably fair to say that never before has policy been so accommodative when the Fed is so close to hitting both its targets. We are in uncharted territory here. We don't know how the Fed will (re)act. If they follow the Bank of England, the next question is how markets will react.
For now, however, I think it is OK to enjoy the euphoria of the 5-1 victory and we we'll think about the new challenges as they come closer. The Socceroos are the next hurdle for Louis van Gaal's men. Easy, peasy, surely.... Or is complacency on my part already setting in?