US Dollar-euro parity in sight
To raise or not to raise: the uS Federal reserve Building in Washington, DC. the probability of a rate-hike in December now exceeds 80% - delivering the first rise in borrowing costs THERE we go again. Even before the ink is dry, global growth forecasts are downgraded once more.
Paris-based OECD’s (rich nations’ think tank) November Economic Outlook attributes a slump in the growth of world trade (brought about partly by China’s slowdown) as the major factor behind the sluggishness of the global economy.
It was only in October that IMF estimated world GDP will grow 3.1% in 2015 and 3.6% in 2016, in the face of slowing global trade at 2.8% this year (3.9% in 2016).
Now, OECD thinks global growth will ease to 2.9% (3.3% in 2014) and recover modestly to 3.3% in 2016.
Even these, I think, are optimistic. Bear in mind that growth in world trade had slackened in recent years (falling behind global GDP growth which is unusual and not a good sign) and has stagnated since late 2014. It is expected to grow only 2% this year against 3.4% in 2014 and a much faster rate in the early years of the decade: “World trade has been a bellwether for global output, and that global trade growth observed so far this year have in the past been associated with global recession.”
Meanwhile, further GDP slowdown in emerging market economies (EMEs) is weighing heavily on global economic activity. In addition, sluggish trade and subdued investment and low productivity growth are checking the momentum of recovery in the rich nations.
Indeed, there are already signs that many advanced economies are unlikely to reach anywhere near their potential output, despite continuing easy money. Over the medium term, the risks of recession and deflation have become more probable than indicated by the IMF.
Because of recent headwinds, the probability of recession in eurozone and Latin America has risen beyond 30% and 50% respectively, with Japan now in recession.
Simultaneously, the probability of deflation in eurozone and Latin America now exceeds 30%, while Japan is already experiencing significant deflationary tendencies.
This raises the spectre of secular stagnation (what Harvard’s Larry Summers refers to as the inability of an economy to grow to reach its full potential) at a time when policymakers are running out of firepower – fear that the policy tools available to combat deflating forces are becoming increasingly blunt.
The immediate risks
As I see it, many factors are shifting the global economy into a secular slowdown. Immediate risks include:
> Continuing deficient global demand in the face of excess capacity: The rich nations as a whole are in growth recession, with the US pulling-up the others which are struggling to jump start anaemic output. The eurozone is in extended stagnation; growth if any is low (in Germany) and uneven; indeed, the region is flirting with deflation.
Consumer prices have turned increasingly negative in Q3’15. Abenomics is faltering, moving Japan into recession (-0.7% in Q2’15 and -0.8% in Q3’15). IMF predicts the biggest contributors to global growth in 2015-2020 are the faster growing EMEs. Among the top 10, only two are rich nations (US & UK); heading the list are China (accounting for nearly 30%), India (15%) and US (10%); the remainder being (in descending order) Indonesia, Mexico, South Korea, Brazil, Nigeria, UK and Turkey.
> Falling commodity prices: Energy, food and metals prices have fallen significantly over the past year. As a whole, commodity prices are now down 51% from its peak on April 29, 2011. Oil price has fallen 61% since June 14 and is languishing very near US$40 a barrel last weekend. Gold price lost 9% so far in 2015, dropping to a 5-year low at below US$1,065 per troy ounce on Nov 18.
Already, weary investors have begun to sense an end to the raw materials rout, as prices for most dipped below production costs. But few expect a quick rebound. The historical record: after commodity prices tipped over in 1997, it took 21 months to correct the fall. In 2000-01, it was 13 months.
After collapsing in 2008, commodity prices hit bottom in just eight months. This time, the index has been falling for four years and still counting. Nothing preordains a turnaround. Studies of commodity prices dating back to the 19th century found that cycles have been known to last 30-40 years.
So, don’t raise your hopes. Off-setting these “cuts” are currency weaknesses in many commodity-exporting nations since most commodities are priced in US dollar - thus translating to higher revenues in local currency, at least for now.
> China slowing down; so are EMEs and BRICS: Latest data points to an Asia where growth is stabilising in the region of 5%, reflecting very low growth in the more advanced Asian nations as a whole, where growth was at 1.5% annually (with South Korea and Taiwan expanding about twice as fast).
Asian EMEs are decelerating from close to 8% in 2011 to 6.5% or less in 2015. China is down to 6.8% this year but India is doing well at 7.3%. Similarly, the Asean 5 (Indonesia, Malaysia, Philippines, Thailand and Vietnam) is also slowing down, from 6.2% in 2012 to 4.6% expected this year.
Within the region, performance is mixed: Thailand is doing rather badly at 2.5%; while growth in Vietnam will accelerate to 6.5%, with the Philippines not far behind at 6%.
Both Malaysia and Indonesia will each grow at around 4.5% this year and not much more next year. Expectation is that growth in Asean 5 will likely stabilise in 2016 at between 4.5%-5%.
The BRICS (Brazil, Russia, India, China and South Africa) will continue to slacken considerably, growing at less than 2%, dragged down by severe recession in Russia and Brazil and hardly any growth in South Africa. EMEs now face a host of problems constraining their ability to grow.
Plummeting commodity prices, BRICS’s slowdown and investor flight are exposing deep-rooted weaknesses requiring fundamental economic overhauls, but made difficult by domestic politics and corruption. China’s successful transition towards a slower, but a more sustainable growth path will benefit growth all round, despite disruptions generated by rebalancing reforms, notwithstanding China’s sizable buffers available for it to cope.
> Rising US interest rates: The spectre of Fed uncertainty over the rate uplift that has spooked world markets will soon end, hopefully. The probability of a rate-hike in December now exceeds 80% - delivering the first rise in borrowing costs for nearly a decade. Expectation is for a quarter of 1% rise, with gradual but orderly small bites over the coming year. No big deal really, considering that Federal funds rate is already close to zero (below 0.2%) today and the yield on 5-year US Treasuries is only 1.65% per annum.
> Strengthening US dollar: The consensus is for US dollar to continue to strengthen, reflecting its relatively strong economy and prospects of a near term rate-hike in the face of economic weaknesses world-wide. The US dollar index (against six of its peers) has tipped past 99.6 (up 10.3% so far this year) for the first time since April.
Odds are for euro to be at parity with the US dollar; it has already touched 1.05. Tge euro has depreciated 13% so far this year.
The Chinese yuan is stable since this summer’s policy change. It is now likely that the yuan will be included in the SDR basket of elite currencies before year-end – in practice, bestowing on it reserve currency status.
Against a basket of EME currencies, however, the JP Morgan US dollar index is up 13.7% over the year; the Brazilian real is down 30.1% so far this year (until December 10); Malaysian ringgit, -20.2%; Turkish lira, -18.6%; Mexican peso, -12.1%; and Indonesia rupiah, -9.9.
Most certainly, Malaysia’s strong economic fundamentals don’t deserve a near 30% currency downgrade over the past year – it’s over-depreciated by at least 10%-15% after discounting the “bad” politics.
US President Obama (in Malaysia recently) is right to emphasise the critical importance of accountability and transparency, and the need to root out corruption in government.
> Destabilising politics and conflict: G-20 continues to struggle to come up with workable viable steps to reshape an increasingly dour economic outlook. They also face a host of new troubles, from political problems to security crises, raising doubts about preventing the global economy from falling into a long-term funk. Now, the growing refugee crisis in Europe and renewed fears of widespread terrorism after the Paris, Sinai (Egypt) & Bamako (Mali) attacks are proving difficult to fix. Soon enough, these heinous acts will become a pressing economic and business issue, bringing with it far reaching pressures on recovery efforts on the global economy.
What then, are we to do
So it’s not surprising that global economic prospects are repeatedly marked down in recent years. Add to this calls to join-in the war to fight terrorism with its multi-faceted business implications.
What’s worrisome is the rising risk of a world economy persistently mired in sub-par growth – as though hysteresis (impact of past experience on subsequent performance) has taken hold, with the attendant unacceptably wide income disparities, serious security issues, and persistent unemployment.
There is also the need to address the “large-scale displacement of people” with far reaching humanitarian development dimensions. Given that the global economy is still faced with much economic slack and very low inflation (indeed, even deflation), the complex challenges ahead will require continued monetary accommodation and fiscal support, notwithstanding frequent disruptions arising from China’s and EMEs’ reform transition, in the face of financial market volatility emerging from the pending Fed rate lift-off and the prospective strengthening of the US dollar.
Warren Buffett is known to have said: only when the tide has receded can you see who has been swimming naked. Cheap QE money has spoiled EMEs. Traditionally, debt busts in EMEs are centred on their sovereign US dollar denominated bonds.
Today’s “naked” EMEs reside in the corporate sector, mostly exposed to local currency bonds.
Their total private debt now far exceeds 100% of GDP, even higher than it was among the rich nations on the brink of the 2008 financial crisis. In the face of a debt crunch, they can become unduly vulnerable, especially for EMEs with a difficult and uncertain future.
Clearly, tepid and uneven growth raises the risk that can tip an economy into recession. Easy times have come & gone. Much soul searching lies ahead.
By Lin See-Yan What are we to do?
Former banker, Harvard educated economist and British Chartered Scientist Tan Sri Lin See-Yan is the author of ‘The Global Economy in Turbulent Times’ (Wiley, 2015). Feedback is most welcomed; email: starbiz@thestar.com.my.
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