Barclays Wealth Q3 Economic Outlook Report ‘Signpost’ reveals there are three big issues facing the global economy
- The risk that US consumers don’t increase spending
- The risk that the EMU collapses
- The risk that inflation fears encourage Asian policymakers to put on the brakes
Barclays Wealth Quarterly Economic outlook report ‘Signpost’ published today advises that the risks of a serious shortfall of global demand have risen, commensurate with policymakers in some countries tightening fiscal policy too aggressively for their own good and that central banks have used up most of their ammo.
Michael Dicks, Chief Economist at Barclays Wealth, said: “The first big issue facing the global economy is the reluctance of the US consumer to spend, with real household disposable income well below what it normally is at this stage of the economic cycle. The outlook here is worrying: the recovery could easily stall or peter out in 2011.”
‘Signpost’ states that the second issue is whether or not EMU will survive. Fixed exchange rates make it difficult for countries to engineer gains in competitiveness, and dramatic fiscal tightening won’t necessarily help much if it leads to further declines in GDP. So, EMU could well change form – and perhaps even break up entirely.
Michael Dicks commented “Since Greece cannot devalue – unless it leaves the EMU and creates a new drachma – Greek firms won’t see any great improvement in competitiveness, following their adoption of a joint EU-IMF adjustment programme. Indeed it may even deteriorate as firms find themselves facing higher tax burdens and much weaker domestic markets to sell into. But worse is to follow as German policymakers have chosen to now accelerate plans to rein in their own budget deficit and this decision has had the effect of ratcheting up how much other euro-area governments are expected to do. This is the reason we have lowered our euro-area growth forecast for 2011 to just 1%.”
The final issue highlighted in the Q3 Outlook is that of Asian inflation. The region’s ability to grow at an above-potential pace will be constrained by inflation fears. Worse still, Barclays Wealth Research suggests that Chinese inflation may be quite sensitive to shifts in the output gap. When it is positive, as currently, inflation normally rises several percentage points. So, a substantive tightening looks to be warranted. But China and the other major regional economies still look unlikely to slam on the brakes. If so, then markets may continue to worry about growth being unsustainably fast.
Investors appear to be placing near-equal weights on the possibility that the global economy will find its feet again and on the scenario where things go from bad to worse. Barclays Wealth shares this assessment of market outturns being a “bi-modal” world. Accordingly, current investment recommendations are to hold a “barbell” portfolio, in which certain components will perform well in both good and bad scenarios. Thus, a cash underweight to finance overweights in both bonds and equities.”
- The US economy, having grown fast at the end of last year, is now moving down a gear or two . The US consumer is proving parsimonious. The labour market looks lacklustre. Monetary policy may have to be kept loose for longer.
- Almost all euro-area governments have announced fiscal tightening packages, with Germany leading the way. But the boost to export competitiveness from euro weakness may help avoid a “double-dip” recession.
- The UK also plans substantial fiscal tightening over the next few years, with much of the squeeze coming in 2011. But continued worries over inflation – which remains above target – may limit the room for monetary policy to provide support for the economy.
- In Japan, the economic recovery looks set to slow during the second half of the year. Japan’s fiscal problems have come back to the fore. Sustained deflation is likely to keep interest rates at low levels.
- In China, growth has moved down a gear over the last two quarters. But it is still powering ahead. The policy dilemma faced by the authorities is that, with the economy still growing so strongly, and with no spare capacity, inflation has risen – and looks set to continue doing so.
- Many other developed European markets are doing relatively well, often helped by better fiscal fundamentals.
- Developed Asian economies are expanding more vibrantly than expected, although inflation casts a shadow.
- Emerging markets continue to grow, but at a slower pace. Here, too, rising price pressures are evident.
- Outside Europe, most other emerging markets’ fiscal positions are still in fairly good shape, with India one exception.
- Global equity markets performed very poorly in the second quarter. On a simple GDP-based valuation approach, equities remain cheap, but hopes must be tempered by polarised investor expectations on the global economy.
- In fixed income, global economic fears have prompted significant repricing of short-term interest rate expectations. Risks are posed by fiscal consolidation.
- In a world dominated by polarised expectations, corporate credit could easily underperform further. Emerging market sovereign spreads have also started to widen earlier than we expected.
- Relative to fundamentals, commercial property markets in Europe and Asia appear to be close to “fair value”, whereas the US, UK and Japanese markets still look cheap.
- Commodities prices fell sharply in both Q1 and Q2 of this year. Growing global industrial production and Chinese demand should help support prices in future. But risks remain.
- In FX, relative interest rates and fiscal outlooks are likely to be the main drivers. The dollar looks set to weaken as US growth slows and the fiscal outlook deteriorates. Sterling looks set to recover further during the second half of this year, but the euro stay under pressure.