Weak trade growth in the midst of an economic recovery, ongoing currency wars and the divergence of emerging and developed markets could well continue to shape next years’ economic prospects, according to Schroder’s Keith Wade.
The chief economist and strategist says that the asset management firm will officially update its global growth prediction for next year, reducing it from 2.9 per cent to 2.5 per cent.
This will be the fifth consecutive year that Schroders has predicted this level of growth for the world economy, and Wade believes that this flat level of growth will become the ‘new normal’.
There have been a number of headwinds impacting the global economy and growth levels this year, one of which has been the drop-off in commodity prices. The chief economist says that, while this has negatively impacted emerging markets as expected, it has also caused divergence between emerging and developed markets.
“It was always going to be a difficult year for emerging markets because the dollar has been strong, it started the year strong and got even stronger, so that obviously weighs on the emerging markets. The fact that it’s been a difficult year for commodities as well has had a very significant impact,” he said.
“That said, I still think it’s interesting that the recovery in developed markets hasn’t prompted the kind of recovery we’ve seen in the past in the emerging world, and one of the keys to that has been the weakness of global trade. If you think of the links between emerging markets and developed markets, then trade is clearly one of the key links.”
Performance of indices over 5yrs
Source: FE Analytics
Global trade is growing at its slowest ever rate outside of a recession, which Wade says is strange in itself, but this has been made even stranger by the fact we are technically in a period of economic recovery.
However, he says that the nature of this recovery is different from previous cycles as it is far weaker than it has been previously and has been influenced by differing factors.
“When we’ve had recoveries in the past they’re usually very driven by credit, the housing market and often a big upswing in durable consumption, and none of these factors have really been a feature this time,” he explained.
“Housing markets have recovered in the US, the UK and Europe, but they have recovered on the back of very low trade volumes and very low credit growth, so mortgage borrowing while it’s been recovering is nothing like what it was before the crisis.”
As a result, Wade says that the recovery hasn’t fed through into the traded goods space, and this has of course been intensified by the aforementioned commodity price collapse and US dollar strength, leading to valuations that are similar to those seen during the previous two recessions.
This is in stark contrast to how the economist expected the consumer sector to behave at the beginning of the year, as he thought the global economy would get a significant boost from the fall in oil prices.
“We have actually seen consumption improve, but the disappointment has come when you look at the way the energy sector and energy-producing countries have reacted, and what we’ve seen in the US for example is a big fall in energy capex which is obviously related to what’s been going on with shale gas,” he said.
“Because the shale gas industry has cut back so aggressively, that’s actually outweighed a lot of the gains we’ve had on the consumption side, netting off a lot of the improvement.”
One of the major changes that investors will have to get used to, Wade adds, is that the US is now a significant energy producer so no longer benefits from a fall in oil price in the same way that it used to.
Performance of indices since start of data
Source: FE Analytics
Emerging markets have of course been hardest-hit by oil and commodity price falls, as many countries within this area are dependent on exporting raw materials.
One such country is Saudi Arabia, which has started to withdraw money from its sovereign wealth fund as a result of the oil price collapse. Many other emerging market countries don’t have the luxury of a sovereign wealth fund to dip into, however, and Wade warns that government spending habits will simply have to be altered in many regions to counteract reduced levels of income.
“A lot of emerging market countries don’t have sovereign bonds or they can’t issue bonds and keep spending in the same way - that’s something that we’re watching very carefully because we think it could put quite a bit of pressure on some of the emerging economies as we go into 2016, particularly since some of them have been downgraded,” he continued.
The final reason that Wade believes growth will remain sluggish is the currency wars that have been occurring this year. While he says that regions have reached somewhat of a truce at the moment, this could be set to change following Mario Draghi’s announcement that quantitative easing in Europe will be extended past the original September 2016 deadline.
Performance of currencies in 2015
Source: FE Analytics
“The US dollar has obviously appreciated significantly this year, and that’s something we’re thinking about when we’re discussing our outlook. We’re thinking about how that is going to affect the US economy in 2016 and we are trimming our forecast for US growth next year. We don’t think the US will have a recession but we think the US economy is going to grow at something like 3.4 per cent whereas, back in early summer, we were looking at more like 3.8 per cent. We’ve partly cut this back because of oil but also because of the strength of the dollar,” the chief economist said.
“The US is not a huge trading economy and relies 70 per cent on its own domestic production, but the dollar will have an effect on its margin and it will certainly have an effect on inflation.”
Meanwhile, he says that Europe and Japan will be the clear winners of the currency wars due to their use of quantitative easing which will devalue their currencies. However, he warns that China could see deflationary pressure as a result of the renminbi tracking the US dollar’s performance, and that on the opposite end of the spectrum, the Russian rouble and the Brazilian real have plummeted due to loss of trade.
“For Russia and Brazil this falling exchange rate largely reflects the collapse in commodity prices, so it’s not really reflecting good things about those economies,” Wade continued.
“I would say that the Russian rouble does appear to have stabilised a little bit but the real remains weak and that remains a concern. Obviously with the Fed tightening, this could add further pressure.”
“On the whole, as we go through next year and the next few months we will see the headline rate of inflation pick up, but because of that base of lower energy prices and the fact that wages are still growing, we’ll see real incomes being squeezed, and that will continue to slow down consumption.”
