The “new normal” of slow growth

The “new normal” of slow growth, low interest rates and near-deflationary conditions that has dragged down the developed world since the global financial crisis is likely to spill over into the emerging market arena

In this environment, Invesco Chief Economist John Greenwood (in his quarterly economic outlook for Q3 2015) expects central bank policy rates and yields on fixed income securities to remain lower for longer. For equity markets he projects slow top line growth accompanied by modest bottom line growth, with continuously high stock market multiples reflecting the very low level of interest rates. At the same time, Greenwood believes that corporate share buybacks may help to boost earnings per share, providing a positive background for investors.

“While near-zero central bank interest rates and quantitative easing (QE) have been effective in promoting a wealth effect through higher equity, housing and bond prices, slow growth of broad money and credit together with low income growth across most major economies have made it more difficult for households and institutions to repair their balance sheets and restore normal spending growth,” Greenwood says. “For that the world needs faster growth of money and credit.” Invesco’s chief economist reaffirms his long-standing view that the current global business cycle expansion will be an extended one as sub-par growth and low inflation avoid the need for the kind of tightening policies that would bring an early end to expansion.

For now, only the US has witnessed a return to normal money and credit growth and even here, the already five-year-old recovery is only now starting to take on the typical characteristics of a normal recovery. Meanwhile, the upturns in the Eurozone and Japan remain fragile, with the renewed eruption of the Greek crisis and the risk of contagion threatening to undermine the recovery in the Eurozone periphery. Among the emerging economies, the big four – China, India, Brazil and Russia – have all been slowing or are in near-recession. Due either to stagnation in world trade and/or continued weakness in commodity prices, growth in other emerging markets has also remained weak.

Against this background, Greenwood expects the wide divergence in monetary policies in the US and the UK on the one hand and Japan and the Eurozone on the other to persist. The European Central Bank and the Bank of Japan are expected to continue with their QE programmes and near-zero policy rates until well into 2016. Depending on the strength of the US economy, the Fed is expected to finally raise interest rates in September or December, with the Bank of England likely to follow within a matter of weeks. “However, as long as money and credit growth remain ample, the hiking of interest rates should not be confused with a monetary tightening,” Greenwood notes.

As the US economy is returning to a more normal growth rate and economic surveys have confirmed the robust shape of the British economy, Invesco’s chief economist projects 2.3% real GDP growth for both economies in 2015. He expects the recovery in the Eurozone to continue in 2015 with real GDP growth of 1.7% for the year as a whole. “Although QE came too late to prevent deflation, there is no doubt that, if it is focused on buying long-term bonds from non-banks, it could convert what is currently an anaemic recovery in the Eurozone to a more vigorous upswing if carried out on a large enough scale and for long enough,” Greenwood says.

However, as the Eurozone struggles with yet another Greek crisis, Greenwood re-emphasises the fundamental flaws in the design of the monetary union that make it vulnerable to recurrent crisis: “The time has come for the Euro-area’s leaders to face up to the decision: either accept Greek default and Grexit or create a political union that is financially strong enough to underwrite the debt of any entity within it (federal, state, bank, or other). It makes no sense to continue with the pretence that the European Stability Mechanism, the banking union or the reliance on member states obeying fiscal rules are anything other than the Euro-area equivalent of ‘extend and pretend’.”

Meanwhile, despite the 20% depreciation of the yen against the US dollar over the past year, the weakness in world trade is proving a considerable headwind for Japan as a major exporting economy. Greenwood expects 1.0% real GDP growth in Japan for 2015 as a whole. In non-Japan Asia, China and other smaller Asian economies, are facing the twofold problem that they can no longer take advantage of rapidly growing global trade to support their export-led growth model while the structural switch from exports and export-related investment spending to domestic investment and consumption-led growth is inevitably taking time. Greenwood expects China’s official real GDP growth to be 6.9% this year, with private sector estimates suggesting substantially slower growth.