John Greenwood’s quarterly economic outlook – Q4 2018

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  • 22 mins 22 secs

With problems in emerging markets continuing to grab headlines and an escalation of the tariff wars between the US and China, how concerned is John Greenwood, Invesco Ltd’s Chief Economist, about the potential impacts on the global economy?

  • Problems in emerging markets continue to grab the headlines. Has the situation deteriorated further there and how high is the risk of contagion from these problems?
  • China continues to loosen both monetary and fiscal policy in response to a weakening economy. Should we be concerned about the growth outlook there?
  • The UK economy appears to have picked up a bit. Can that continue while Brexit uncertainty remains elevated?

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John the potential negative consequences of trade war still remained many investors major concern in the last month or so. We've obviously had revised nafta deal, but at the same time we've had an escalation of the terror of war between china on dh, the united states. The last time we spoke, you were relative iraq's about the potential consequences of this. Has your view changed at all ? Not significantly. The important point to keep in mind always is that what really matters for countries is the state of domestic demand. The mistake that people make is to associate tariffs like the smoot hawley tariff in nineteen thirty with the great depression, whereas actually the great depression was caused by contraction of domestic demand on the tariffs were peripheral to it. This time we have central banks ensuring that domestic spending is growing at rates, which are consistent with their inflation mandates, and therefore the impact ofthe trade measures and tariff measures is pretty marginal for the u s it's still fractions of a percent for china, it might be a little bit more more like one one and a half percent or something of that nature, but yes, you're right ? The u s m c a u s mexico canada agreement has replaced nafta on that is forced some opening of the canadian dairy industry. It's raised domestic content requirements in the auto business for china for the us excuse me, andi it's also made it much more difficult for either mexico or canada to do a free trade deal with china non market economy so that the u s domestic market can't be undermined by those countries buying components let's say more cheaply from china on dh, bringing them in directly into the u s as far as the china trade is concerned, in the last three months in july, august and september uh, two hundred thirty five billion dollars off chinese exports into the u s have been targeted with new tariffs, but those tariff levels are still pretty low and ten percent summat fifteen percent but not the higher scale yet s o the impact so far is still very small, and aziz, i say, as long as the u s continues to maintain domestic demand growth good right, then i don't think that globally we're going tto go into any kind of major downturn on another area of concern is the elevated level of debt, both in developed markets on dh emerging markets. In fact, in the latter, we've seen sharply rising level of debt there. Should we be concerned about that in the developed markets ? First of all, the countries which have failed to d leverage are principally japan and the euro area onda as a consequence, we've seen slower growth in those areas. The point that i always make is that what is really important for growth is private sector indebtedness, government debt matters, but it's secondary to private sector debt. Certainly some of the major european countries have not yet done enough to bring down leverage. Now in the emerging markets, we've seen some countries buildup that quite rapidly and others have got into trouble. I would distinguish strongly between countries like no china and korea on the one hand which have high debt levels, but our controlling domestic spending uh, so they need a period of gradual de leveraging versus countries like argentina and turkey which have had very rapid growth of credit. Andre and leverage and have got into trouble is a result of that just sticking on on on. Emerging markets obviously a number of emerging markets been grabbing the headlines recently. How concerned are you that you know there is a risk of contagion from from these problems both into other emerging markets and also into the developed world ? The country's air got into difficulty, i would say our countries which have largely created their own problems. So for example, in turkey, the rates of growth ofthe money and credit have bean of the order of seventeen to twenty percent per annum for the last five years and more that's an excessive rate of growth in argentina, they've been even higher between two thousand eight. In two thousand sixteen, money credit grew up something like twenty five percent per annum and under president macri, it's grown even faster at twenty nine percent. So it's hardly surprising those kind of growth rates have produced abrupt currency weakness. It's not due to rising fed rates or a stronger dollar it's they've created their own problems. The possibility for contagion, i think, is limited to those countries which are perceived to be in the same boat. Now if you look at the leading smaller asian countries. Korea, taiwan, singapore, malaysia, thailand etcetera, the only country in that region which has really had a problem is indonesia and then more recently india. The north east asian countries have been very successful in controlling money and credit growth and demand and they've really not suffered much contagion a tool indonesia has been heard about maurin recently we've seen the indian rupee also hurt, but those reflect either subsidies on fuel which have been lifted and therefore that's raised inflation or other problems. It's not really excess demand so i would say that the contagion this time, unlike the asian financial crisis in ninety seven ninety eight, where contagion really spread right across the region, it's going to be limited to those cases where policy has been inept and certainly no into developed markets. No, of course all countries are seeing the experience, the the consequences off a stronger dollar and rising u s interest rates on this prop, these periods are always challenging in all markets. China clearly very important economy globally of second largest in the in the world, we've seen some sort of weakness there recently and as a consequence that authorities have bean loosening both monetary and fiscal policy there. Should we be concerned about the outlook for the chinese economy ? I don't think so it's important to understand that the key policy, i think, is to de leverage the economy having built up the successive debt between two thousand eight on two thousand sixteen as a result of their response to the global financial crisis on the growth of the shadow banking market, china has implemented a deliberate policy of de leveraging, but at the same time key segments of the economy of weakened the housing market is weakened and some of the basic raw material basis icka industrial sectors have weakened excess capacity and steel in chemicals and cole and so on. Now, the response off the authorities has bean to lower interest rates and reduce reserve requirement ratios, but we're not seeing credit money growth accelerating. So if you like what's happening, is that the demand for credit is weaker and interest rates on reserve requirement ratios are being lowered to respond to that. But this is not creating a new problem of rapid credit growth. So i think china will continue to grow that's something like six percent on the official figures, but i don't think it's problems of indebtedness and song will accelerate from here in the united states, we've seen the ten year u s treasury hit its highest level since april twenty eleven so harsh level for over seven years. Does it reflect concerned about inflation, or is it just symptomatic of a strong growth backdrop ? I think it reflects both, as you say, the treasury yield has just gone north of three point two percent tenure and there is widespread concern about inflation, but i think that that inflation concern is misplaced. It's based on two ideas, one is that, um, the u s labor market is getting very tight on dh under the sort of philip's curve a theory when the employment market gets very tight when unemployment falls, you typically get inflation, and the other theory is concerned with the output gap. But when the economy reaches full capacity, that tends to trigger cost pressures. But the truth is that these things are happening after a long period of fairly steady growth against a background of low growth of money and credit. No, inflation is fundamentally monetary phenomenon, so unless you have rapid growth of money and credit, you're not. Going to get inflation so i think that all those fears of inflation our present, the actual inflation will remain relatively subdued. That said growth is buoyant and continues to be currently in excess of three percent. I think this is a temporary phenomenon due to the tax cuts, but in the medium term the us khun still continue to grow probably two, two and a half percent which is pretty satisfactory and that's alone. We'll push up interest rates a bit further and in addition we have a large fiscal deficit which will crowd out some private sector borrowing so those factors will tend to push interest rates a bit further on. So i think we should expect the ten year treasury to move further up words. This is not anything kind of unusual, i don't think that's what we should expect at this stage in the cycle on dino, i suppose another factor play here is the fact that the fed continues to hike rates. We had another rate hike in september, the eighth this cycle on the fed chairman jay powell seems to be quite keen to sort of raise rates potentially quite materially higher from here. Yeah, how do you see that as the risk of a policy era increased ? No, i don't think the risk of a policy era has increased, but aziz say the fed has become increasingly confident that the economy is in good shape and therefore they can normalize rates it's important to understand that they are normalizing rates, they're not tightening with a view to terminating or ending the business cycle and expand because inflation is simply not not a problem, not an issue. At the moment. At the september meeting of the federal open market committee meeting, they released the summary of economic projections on the median expectation for the fed funds rate in twenty nineteen is three point, one percent on dh in twenty twenty to reach three point four percent. So there are some expectations that it will be higher than that some expectations that it will be lower than than that, but that's a kind of midpoint estimate. So yeah, rates will certainly rise probably another at least another four hikes from where we are the moment two, two and a quarter for further hikes of a quarter percent each time i think they'll be spread out. Over the next eighteen to twenty four months, and depending on the situation at the time, the analogy one should draw is with the mid course corrections or rate hikes that we saw in nineteen, ninety four, ninety five and two thousand four, two thousand five. This is not about raising rates to squeeze the economy, but just getting back to a normal level so that the economy can continue to grow with decent growth and low inflation for several more years on the unwinding of cuba will continue apace as well. Yes, that's occurring with less disruption than i myself had expected and it's happening because banks are continuing to lend their growing their loan book at about five percent and as a result, money growth deposit growth on the other side of the bank's balance sheet is also growing at about five percent that's about right for a man inflation target off two percent for the us economy. So i think that provided that the fed can keep things on the current cause, then we have probably have several more years of expansion ahead. We don't often talk about japan, but, you know, the nikkei has recently hit its highest level since nineteen ninety one is that reflective ? Ah better backdrop for the japanese economy ? I don't think the economy has improved dramatically, the economy continues to grow in a sort of one to one and a half percent range at best that's partly due to aging and the decline in the size of the labor force on a per capita basis is fractionally more than that. But it's not dramatically better. Like other countries, japan has seen a reduction in the rate of growth of productivity. The problem it more generally is that the the part of abba nomics the arrow directed monetary policy is not working to raise the inflation rate two, two percent actual inflation is still falling well short of the target, and i don't think that will change. So essentially we're seeing japan moving into a sort of i mean, a steady state growth where the economy has low growth, low real growth one one half percent on then on inflation rate, which is one percent at best. That would be consistent with current rates of growth of money and credit, so the stock market is gradually starting to reflect that i'm the yen, of course, has weakened somewhat and that's helping their comparative advantage. I don't think it's a signal that japan is suddenly going to be transformed, but a steady policy of her long period is started starting to bear fruit moving closer to home, it is grabbing the headlines again, not necessarily further for the right reasons. I mean, how do you see the situation there should be concerned about it. It really illustrates a number of no problems. The first is that the monetary union has become too big. The way i'd like to express it is that italy is like a boxer who is put into the ring, but one arm is tied behind his back because monetary policy it is out of bounds. It's not allowed to use monetary policy to make adjustments that is done by the european central bank. Fiscal policy is not available because there are rules from the you on budget constraints. And finally thirdly, the country cannot adjust its exchange rate so all the major tools of macroeconomic adjustment are simply not available. Currently, italy has a government budget dead of around one hundred thirty percent of gdp, and that really hasn't changed for the past decades since the crisis of two thousand eight and i see very little prospect of that coming down without it lose growth, improving on dh the prospects for that happening quite remote, so it will continue to be a dragon a problem. But it's also hard to see the problems escalating dramatically. What we've had recently is a confrontation between this radical government made up of populists on the left and the right threatening to take on brussels and then seemingly backing off. I suspect the price of leaving the eurozone is too great for them to contemplate that and therefore they will continue to toe the line but it will mean that it is not going to grow very much on the situation isn't going to improve in any fundamental fundamental way. Funny from an economic perspective, the uk economy seems to have picked up a bit, but obviously we are in the sort of danger zone now in terms of sort of brexit negotiations, sittings evolving i think the growth is frankly, a bit random on according to quarter basis. So yes, we've had a slightly better three month period seemingly compared with previously but the bigger picture is that since the brexit decision, corporate investment has been stalled on the property market has also bean quite a bit weaker those things i'm not going to go away until we see the clear post brexit framework on businesses can make decisions based on that. I think that the uk is actually it used to grow more rapidly than europe it's out converging more to a sort of european style growth rate of one and a half to two percent, rather than the sort of two to two and a half percent american star growth rate that we used to have. But hopefully if we get a sensible agreement when the economy can improve, though i think we should expect or anticipate some disruptions around the transition period. Andi, against this backdrop, carney will continue to be sort of on the side of caution, i suppose. Yes, i think that any rate hikes will be postponed if there's any hesitation about the economy or business confidence, as we've seen him do previously, so i think that i'm uk interest rates will probably not rise very much until after march next year, which means that they're roughly coincide with the possibility of change in policy in the latter half of twenty nineteen and wrap it all up. I mean, the conversations obviously highlighted a number of concerns that right there, i mean, what does this mean for financial markets from here ? Periods of rising interest rates in the us are always challenging for financial markets, and the thing to keep in mind is that this is a what i call a mid course correction it's analogous to the rate hikes that we saw in nineteen ninety four ninety five, two thousand four, two thousand five. In each of those cases, the u s business cycle expansion, which is important for risk, as at markets, equities and real estate across the developed world, those markets or those the economy has continued to expand for two or three years after those rate hikes in the nineteen nineties. Six years so there's no reason why this time the economy's shouldn't continue to expand after this siri's of rate hikes comes to an end, though europe will probably be starting to raise rates after the fed completes its current rate hikes. But again, that's that will be a normalization rather than a tightening to end the cycle. And historically, the peaks in stock markets and in real estate markets have not come until close to the recession. So that leaves open if you go by the historical analogy, the possibility that financial markets can make progress after these rate hikes are completed. John, thank you very much.

 

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