Invesco – Economic Outlook for 2016

With the Federal Reserve starting on a series of Fed Fund rate hikes from 16 December 2015, US money and credit markets will be on the path towards normalisation after seven years of abnormally low rates.

This is a sign that, despite the weakness in emerging economies, the US is back on the road to normal growth.
However, the key indicator to watch will be the rate of growth of bank credit. The US is the only major economy where bank credit growth has returned to normal (6-8% p.a.) and it is critical that, in the aftermath of rate hikes, credit continues to grow at roughly the same rate. If this happens, then equity and property markets can shrug off the early phase of rate hikes.
Assuming no tightening of credit conditions, I expect US real GDP growth in 2016 of 2.6%, and CPI inflation of 1.4%.

By contrast, the Eurozone and Japan are still in the midst of extended programmes of Quantitative Easing intended to boost the rates of growth of money and credit, and hence the economy as a whole.

With the Euro-zone are likely to grow at between 1.5 and 1.7% in 2016 and Japan at 1.5% the central banks in these economies are therefore at least a year if not more from hiking rates. In both cases there are faults in the design of the QE programmes that need to be rectified in order to make them more effective.

The upswings in both the Eurozone and Japan have slowed somewhat in recent months, demonstrating that the underlying recoveries in the US and the UK are inherently more sustainable than the – as yet — fragile upturns in the Eurozone and Japan.

The divergent monetary policies of the Fed (and possibly the Bank of England) on the one hand and the ECB and BOJ on the other could result in some further volatility in the currency, fixed income and equity markets.

In particular, the US dollar will probably appreciate further while the euro and the yen might depreciate further. This may weaken the earnings of large US companies with large sales overseas, but medium and smaller–size companies should benefit from the broadening domestic recovery.
The overall picture is one in which both growth and inflation will remain subdued against a background of several years of very low money and credit growth.

The UK is faced with a similar situation to that in the US — reasonably buoyant economic activity (I forecast 2.4% growth in 2016), but accompanied by inflation well below target. This implies that the Bank of England will not follow the Fed in raising rates until February or May 2016 at the earliest.
In the emerging economies the slowdowns in China, Brazil and Russia are continuing to impact commodity markets, numerous basic industries, and global trade volumes. Beyond that, the struggle among EM producers more generally to regain competitiveness threatens several EM currencies with the need for further depreciation.

The emerging economies face three key problems. First, many of them allowed excessive rates of growth of money and credit in 2009-13; second, most are still overly dependent on an export-led growth model,; and third many of them are very dependent on commodity exports at a time when commodity prices have slumped.

Following the temporary recovery in the price of oil between March and May 2015 to $60-65 per barrel, commodity prices had another setback in 2015 Q3 and inflation rates have continued to remain very low in most developed economies. The widespread inflation undershoot reflects not only the direct effect of weak commodity prices but also the persistent background of slow money and credit growth that has characterised the post-crisis period. Only in the US have money and credit growth rates returned to normal rates.

In spite of these short to medium term setbacks in the recovery process my long-standing view has been that the current global business cycle expansion will be an extended one. The main reason is that sub-par growth and low inflation would avoid the need for the kind of tightening policies that would bring an early end to the expansion.

It is also the case that recessions or growth weakness in the emerging market (EM) economies are unlikely to derail the modest-paced recovery in the developed economies. While some companies or sectors cannot avoid being affected by the problems of the EM, the transmission of key fundamental forces – like monetary policy and balance sheet repair — still goes primarily from DM to EM, not vice versa.

In addition, the recovery in the US, although already five years old, is only now starting to take on the typical characteristics of a normal recovery: banks are now providing credit instead of the Fed, business investment is recovering, and consumer spending is regaining its normal momentum.

John Greenwood – Chief Economist – Invesco