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Economic Outlook (ING)

Diverging regional trends in a sub-par global growth environment. No recovery in Asian trade data visible yet.

Economic Outlook (ING)
Diverging regional trends in a sub-par global growth environment

Last week we argued that there is a real possibility that the global economy is bottoming out at a sub-par level. The main reason is that the benign forces of past decreases in energy prices and monetary policy loosening are starting to exert positive effects on final demand growth. In addition to this, global risk appetite and confidence has been supported somewhat by the fact that the ECB seems to be more willing to act as a Lender Of Last Resort for sovereigns. Nevertheless, the latter remains the most important downside risk to our base case especially because market turmoil may need to rise before the ECB can act. This week we go into somewhat more detail and we will take a closer look at the demand situation in the various regions of the world.

EM policymakers feel constrained
Many EM economies are still pretty export dependent and, as a result, they have experienced a notable slowdown in momentum which is reflected in weak readings on the manufacturing PMI‟s and industrial production growth. In addition to this, domestic credit growth in EM space as a whole has decelerated notably since late last year. This is very different from the first nine months of 2011 when it was on an accelerating trend. One of the main drivers behind this is the tightening of EM lending standards. These were still on a loosening trend last year, a process that is now being reversed due to a deterioration of international funding conditions. The latter, in turn, is very much driven by the fact that deleveraging of EMU banks implies divestment of international activities. Hence, the EMU crisis does not only hit EM space via the export side but also via bank lending.

As we already described last week many countries in EM space have benefited from varying degrees of policy easing and there are some tentative signs of bottoming in these economies. Nevertheless, there are still considerable challenges ahead. In particular, China feels constrained in its easing efforts because of a fear of igniting the real estate bubble again. Meanwhile, Brazil has already eased a lot but is constrained in further efforts as this may cause international investors to loose confidence which could result in tighter financial conditions and credit supply.

In addition to all this, the rise in energy and food prices currently seen will weigh more on EM economies because these items represent a large share of the consumption basket. It may be difficult for EM central banks to react to the concomitant negative growth effects in the context of an output gap that is close to zero and inflation expectations which are not as well anchored as they are in DM space. All in all, it seems hard to see a scenario in which EM growth imparts a large boost to the global picture in the near future.

From a more structural perspective it seems that many EM economies are in need of a structural change in policy. The strategies they have used to revive growth for a very long time (e.g. stimulating exports and investment in China) are rapidly becoming subject to diminishing returns. Hence, a switch should be made towards targeting other sectors of the economy (e.g. consumption in China) through structural reforms (e.g. a more wide-spread social safety net to decrease precautionary savings). Yet, such a strategy focussed on long-term stability may well entail less ability to provide a short-term boost to growth.

US likely to be best performer (again) in DM space
In DM space, the US is once again the economy with the most potential to stage a rebound. It now seems that employment is growing at a rate of a little over 100K per month. Although not spectacular, this is good news for the US consumer who is also benefiting from robust gains in real disposable income growth (up 4% annualised over the past 6 months) on the back of falling inflation momentum. On top of this, the inventory cycle in the US definitely looks less bad than in many other parts of the world as there seems to have been no addition to inventories in Q2‟12. Also financial conditions have eased again over the past two months.

From a more structural perspective, the recovery in the housing market looks better by the month both in terms of house price developments and building activity. Also, US consumers as well as financial institutions seem well advanced in the deleveraging process because of which the drag exerted by this may start to wane next year. This does not mean that all risk is off the table of course. One issue that is coming closer is the fiscal cliff, i.e. under current law there will be an “automatic” fiscal tightening of some 4-5% of GDP. If this were to happen, it would surely throw the US economy back into recession so our base case is that policymakers will do everything to avoid it and limit the tightening to something more manageable in the range of 0.5-1.5% of GDP. Nevertheless, more clarity on this can only be expected after the Presidential Election and in the meantime the concomitant uncertainty may well weigh on consumers and businesses.

The Fed still expects to miss its inflation as well as its unemployment target over the policy relevant horizon which calls for further easing. In this respect, the August FOMC statement had a more dovish tone than the June one by stating that the FOMC “…will closely monitor incoming
information on economic and financial developments and will provide additional accommodation as needed to promote a stronger economic recovery...”. Hence, we continue to expect further measures both in the form of extending the late 2014 interest rate guidance and QE3. When the latter will arrive remains uncertain though.

EMU remains mired in recession
As we have argued before the Euro economy finds itself stuck in a number of interrelated negative feed-back loops and it is hard to see any near-term relief. The fundamental drivers of all this remain the strong deleveraging forces in the sovereign and banking sectors of the economy. These produce both a large fiscal drag on growth as well as an impediment to credit supply. With respect to the latter it appears that lending standards continued to tighten in Q2, albeit at a somewhat smaller pace than in Q1.

The negative growth effects exerted by the fiscal and credit drags also set in motion a more familiar negative feedback loop between labour demand and final goods demand. The EMU unemployment rate (11.2%) thus remains on a rising trend that is unlikely to end which is one of the reasons why consumer confidence remains at the lowest level since 2009. On top of this, consumer as well as business confidence (and hence corporate willingness to spend on either labour or investment spending) are also being negatively affected by continued uncertainty about the fate of the euro.

On a positive note one could say that for now the recession does not seem to be deepening further as the composite PMI has stabilised over the past two months at a level that is consistent with a roughly 1% annualised contraction. Nevertheless, even though the strong divergence between the core and the periphery continues, momentum in the former part of the region has decelerated since early spring. We remain of the view that the only factors that can bring some near-term relief are a pick-up in global growth (which we expect but only moderately so) and a further loosening of monetary policy.

No recovery in Asian trade data visible yet

Early indicators for EM export growth suggest that global trade dynamics are still deteriorating. August trade numbers, particularly in Asia, are likely to be very weak.

Korean exports for the first twenty days of August fell by 4% compared with July and by 11% compared with August last year. The year-on-year growth rate deteriorated sharply from the 2% recorded in July.
In Taiwan, the other big open economy in Asia, new export orders continued to decline, to minus 4% in July. It was the fifth consecutive month in which export orders growth was in negative territory. Orders from Europe and China fell the most.

There is no convincing evidence yet of a pick-up in global demand growth. This is one of the main reasons why the China sentiment has remained weak and why emerging equities continue to underperform developed markets.
China news has been rather light in the past week. In the coming days we will get the flash PMI for August. This number is likely to be weak still, due to the external demand problem. But we expect more evidence of the infrastructure-and-construction-related recovery of domestic demand in the coming months. This should help EM exports in the coming quarters.

By Willem Verhagen - Senior Economist & Maarten Jan Bakkum - Senior Emerging Market Strategist


Vendredi 31 Août 2012

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