In his latest Economic outlook quarterly, Neil Williams, Group Chief Economist at Hermes Investment Management, sets out the four main pillars of his macro outlook for the year ahead.
Handing over the growth baton…
Despite China’s slowdown, concerns about Greece, and the imminence of the US Fed’s first rate hike, global growth should not be completely derailed. But, clearly, these are headwinds, and another reason for central banks to take only ‘baby steps’ to normalising rates.
With the gap in 2015 between advanced and emerging economies’ growth rates, at just 2%, the smallest since the dot.com boom of 2000, the pressure to preserve world growth is tilting back from the emerging to advanced economies.
Our macro outlook is thus based on four core beliefs.
First, not only will US and UK real policy rates stay negative into 2017, but ‘peak’ rates when they come will be much lower than we’re used to, and certainly below the US/UK’s historic averages of about 5%. When they do rise, we expect US and UK rates to ultimately peak at just 3.75% and 2.25% respectively.
The ECB and BoJ meantime will extend their liquidity. The euro-zone will continue to be a monetary union lacking fiscal union. Greece may have to restructure its debt, but this should be felt by official institutions rather than private markets.
Second, these peak rates will ultimately be delivered by central banks running down their assets via ‘QT’ (quantitative tightening). The BoE wants first to see Bank rate back up around 2%, which will take years. This could be part of a ‘disaster recovery’ for Brexit (which is my risk case), which may need extra QE.
Third, China may be slowing, but has the wherewithal to soften the landing. Even with just 3% real growth in 2015, China will have generated over two years nominal growth equivalent to the total GDP of Spain. When it was growing 6-7%, it was generating over two years the equivalent of the total GDP of Canada! Expecting it to carry on generating the GDP equivalent to a G7 country was always unrealistic.
Fourth, despite pockets of vulnerability, a ‘blanket’ emerging market crisis seems unlikely. External debt ratios are generally lower, there are fewer fixed currency pegs to protect, and they can print money (run QE). This makes comparisons with 1994, when most assets were hit hard, look superficial.
Meanwhile, the ‘baton’ looks like it’s being handed back to the advanced economies to fuel world growth, while China enacts an avalanche of stimulus measures sufficient to arrest the decline and avert market turmoil.
If it doesn’t, the US Fed’s rate tightening cycle could prove to be one of the shortest yet. Which all suggest 2016 will be more like 2015 than 1994.
The ball is admittedly in China’s court – but doing nothing would be a bit like ‘a turkey voting for Christmas’!