Worries about Greece appear to have been replaced by concerns about China and the global cycle more generally. It has been a bad start to the year, with global economic growth disappointing. However, advanced economy demand is stepping up a gear, and global industrial production will likely follow. Although downside risks to China’s outlook persist, we still expect a soft landing. Meanwhile, the Fed looks on track for a September rate hike, while the BoE is likely to wait until 2016. Greece appears to be moving closer to an ESM deal, but Grexit risks could well return in coming months.
Worries about Greece appear to have been replaced by concerns about China and the global cycle more generally
Nick Kounis Head of Macro Research
Advanced economy demand is strengthening
It has been a disappointing few months for the global economy, with trade and industrial production weak. However, we see signs that global growth is about to step up a gear. Crucially, domestic demand in advanced economies looks to be in good shape. For instance, US consumer spending accelerated to 2.9% in Q2, confirming that the slowdown in Q1 was a temporary affair.
Retail sales and car registrations in the eurozone showed the opposite pattern, but still continued to grow in Q2 after a robust Q1 outcome. In addition, orders for German capital goods from the eurozone surged in June, a sign that investment in the region is picking up. This is in line with the ECB’s Bank Lending Survey, which showed corporate demand for loans is rising.
Services PMI a strong signal
The Services PMI for advanced economies rose in July and has been on a rising trend over the last few months. The service sector is domestically-orientated and therefore usually a good indicator of domestic demand (see first chart). The current level of the Services PMI new orders component suggests that OECD domestic demand is accelerating to around 3% in the second half of this year compared to the 2% average growth we saw in 2014, and around 2.5% in the first half of this year.
It’s all about demand
In the end, economic growth is driven by end-user demand. The indications that industrial production has been trending below final demand might be a sign that companies have been running down inventories. As this process comes to an end, industrial production and trade will catch up with final demand and global growth will regain momentum in the coming months.
China hard landing fears
But what about China? Doesn’t the slump in the Chinese equity market and commodities suggest that the economy is set for a hard landing? Economic data are not consistent with this view. There is scepticism about the GDP growth data, which show the economy exactly hitting the 7% target in Q1 and Q2. Monthly data suggest that the economy slowed below the target earlier in the year, but has since regained some traction towards the target.
The Chinese equity market is disconnected from the economy. When the stock market was booming earlier in the year, there were no commentators heralding that this signalled a sharp change in the economy’s prospects. Commodity markets are arguably a better indicator, but far from perfect. Some commodities are in a situation of over-supply. For instance, this is a key factor pushing down oil prices. In addition, China’s re-balancing has meant that overall growth is becoming less commodity-intensive.
At the same time, the Chinese authorities will do what it takes to keep growth on track. Earlier in the week, there were reports of a new USD 160bn infrastructure investment plan, which could end up being much bigger. Indeed, the Chinese authorities have plenty of room – both on the monetary and fiscal side – to underpin demand.
The new normal
Overall then, we are less pessimistic on the global cycle than some. That does not mean that we expect growth rates to return to near pre-crisis levels. Trend growth in the US, eurozone and China is now significantly lower. We expect a cyclical upswing with growth rising above the new lower trend rates. However, it will still look moderate compared to past cyclical upswings.
Fed looks set to hike before BoE
The Fed and the BoE are the two major central banks that are widely expected to be the first to raise interest rates for the first time in many years. There has been some speculation about which one will go first. The clear message from this week’s commentary from officials is that the Fed will ‘win’ the race.
FOMC member and Atlanta Fed President Dennis Lockhart made it clear that the central bank was on track to raise interest rates in September. He said that it would take a significant deterioration in the economic data to for him to be in favour of a delay.
Ongoing strong US job growth
The focus is particularly on US labour market data, and these remain strong. Nonfarm payrolls rose by 215K in July following a 231K rise in June. The unemployment rate was stable at 5.3%, though most evidence suggests that the labour market is tightening. Wage growth remains moderate (hourly earnings rose by 0.2% mom in July and 2.1% yoy), but Chair Yellen has said that accelerating wage growth is not a pre-requisite for a rate hike.
Carney keeps an eye on sterling
Meanwhile, BoE Governor Mark Carney signalled more caution and suggested that a rate hike would not come until next year. A key concern for the Bank is that sterling might surge if it is the only central bank raising interest rates. So in a way, it is waiting for the Fed. We think that the Fed will hike rates in September of this year, while the BoE will raise interest rates in February of next year. Both central banks are likely to raise interest rates at a very slow pace.
Greece talks making progress
The Greek government struck a positive note on its talks with the quartet of creditors, which aim to reach agreement on an ESM programme. It aims to pass the deal through parliament by 18-19 August following submission on the 14th. This ambitious timetable is necessary to allow the first ESM disbursement in time for Greece to pay the EUR 3.2bn maturing Greek government bonds held by the ECB on 20 August . The German government has suggested that this deadline is too tight, saying reforms need to be agreed in detail. If Greece does not manage this deadline, another bridge loan would be necessary. Even if that proves to be the case and it takes a little longer, most signs are that an agreement will be reached.
Big obstacles further ahead
However, major risks remain going forward. Greece will need to implement tough measures in the face of a very deep recession. Indeed, recent surveys suggest that the economy has fallen off a cliff (see chart). In addition, the country needs major debt relief, but Germany and other states are reluctant to go too far down this road. Finally, the programme is not fully financed. So the risk of Grexit has not gone away unfortunately. On the other hand, the impact of this risk on the eurozone and global economies looks to be manageable.