The global economy continues to expand, but seems stuck on a moderate, below-trend trajectory. Lately, the story seems to be more about a growth rotation across regions than a clear-cut acceleration or deceleration at the global level. Looking to 2014, however, we still expect the global economy to accelerate to a more trend-like pace.
Japanese activity is picking up steam as well, buoyed by aggressive fiscal and monetary stimulus. Whether this policy shift kickstarts a period of sustainable growth s debatable, especially if the Abe government makes less progress on much-needed structural reform (the third component of “Abenomics”). But macroeconomic stimulus alone could lift growth from an anemic 0.5% pace at end-2012 to an above-trend rate of 2%-3% in 2013, and Japan still contributes 10% of global output.
European data has also surprised on the upside over the past month and while the level of activity remains weak in absolute terms, this may be a sign the region is at least stabilizing as the emphasis on fiscal austerity fades.
Offsetting the marginally better story in the developed economies, however, the picture across the emerging markets has become more mixed, at least cyclically speaking. A particular surprise has been the tepid pace of recovery in China, where the new leadership appears far more serious about balancing social objectives (less corruption, less environmental degradation and more affordable housing in the major cities) against the traditional desire for top-line growth fueled by indiscriminate investment spending. Put differently, the quality of growth now seems to matter too, not just the quantity. As a result, the Chinese leadership appears far less willing to react to sub-8% growth numbers with a jolt of monetary or fiscal stimulus. A better balanced Chinese economy is positive for the global economy over the long-run, but the process of getting there creates some knock-on effects for other countries in the short run, primarily via weaker commodity prices and exports.
Disinflation has been a key theme in the developed countries over the past year, allowing the major central banks to remain extremely accommodative in support of growth. Gross Domestic Product-weighted core inflation across the G7 countries peaked in April 2012 at 1.6% and has declined to just 1.1% since then. We expect inflation to stabilize going forward and move modestly higher, in part because we expect growth to accelerate globally in the year ahead but also because core inflation now seems more consistent with other measures of excess capacity such as average unemployment rates. Indeed, the bigger anomaly is why core inflation accelerated so much in 2011 and early 2012, not why it has fallen back since then. Even if core inflation stabilizes and then edges higher, however, we expect the major central banks to remain highly accommodative this year and next. Indeed, we do not see any rate hikes in the G10 countries in the year ahead, the Bank of Japan has jumped headfirst into the deep end of the quantitative easing pool, with an explicit goal of creating inflation, and we believe European Central Bank (ECB) policy needs to get easier, even after their early-May rate cut.
While we expect monetary conditions to remain very accommodative in aggregate, the U.S. story has started to shift at the margin. Federal fiscal drag is temporarily restraining growth, but this drag should fade over the second half of the year, allowing the more vigorous pace of underlying private activity to shine through. The U.S. labor market has improved and the debate within the Fed over the potential costs of quantitative easing has grown gradually louder over the course of 2013. Prior to late May, the market consensus only expected the Fed to start tapering its quantitative easing program in early 2014. However, Chairman Bernanke’s comments to the Joint Economic Committee on May 22 raised the prospect of an earlier start to the tapering process, perhaps as early as the July or September FOMC meetings. We felt the risk of Fed tapering was growing, but were surprised by the market reaction to Chairman Bernanke’s comments in late-May and early-June. In hindsight, investors became far too complacent that easy money would support every asset class as far as the eye could see and have now rushed to shed risk positions at the same time.
We remain constructive on the outlook for the U.S. currency over the medium term, for several reasons. First, the U.S. dollar remains cheap by historical standards, especially against the major currencies.. Second, while the low level of U.S. rates remains a negative for the U.S. currency, we believe the U.S. economy is much further along in the structural healing process than either Europe or Japan and that monetary policy will normalize sooner in the U.S. as a result. Finally, the ongoing increase in U.S. energy production should, over time, create a positive supply-side shock for the U.S. dollar, something we believe the market has yet to consider properly given the secular nature of the trend. Ultimately, though, we believe the U.S. dollar needs actual not expected rate support at the front end of the curve to generate sustained gains, and this is still a ways off.
Taking a broader view, we believe the U.S. environment is shifting from a story of modest growth, low inflation and unusually aggressive liquidity creation to one marked by better growth, modest inflation and less aggressive (but still quite accommodative) monetary policy. In the abstract, this new environment should remain positive for risk assets, especially for those assets more levered to growth than liquidity. But the markets often handle transitions poorly and a recent spike in volatility suggests they are handling this one poorly too. While painful to go through, these sloppy market conditions are loosening up valuations, creating some opportunities in sectors and currencies with better fundamentals.
The views expressed are as of 6/17/13, may change as market or other conditions change, and may differ from views expressed by other Columbia Management Investment Advisers, LLC (CMIA) associates or affiliates. Actual investments or investment decisions made by CMIA and its affiliates, whether for its own account or on behalf of clients, will not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not account for individual investor circumstances. Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon, and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results and no forecast should be considered a guarantee either. Since economic and market conditions change frequently, there can be no assurance that the trends described here will continue or that the forecasts are accurate.
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