Global Outlook: Elusive Search for Equilibrium
Six years past the bottom of the Great Recession, it feels to many as if the aura of crisis still haunts the global economic landscape. China’s slowdown, thankfully not a hard landing, has been more protracted than many expected. The recent data from the Eurozone, while a bit stronger, are being pushed into the background amidst the seemingly endless effort to resolve the taxing questions surrounding Greek debt payments and Greek Euro membership. Brazil remains in a difficult recession and the Latin American economy has lapsed into a sluggish malaise with the growing realization that fundamental reforms are going to be needed if the region is to ever achieve sustainable prosperity.
Even in the U.S., where economic activity has been stronger and more stable than in most parts of the world, things are still shaky. Frustrations are growing over the historically slow pace of growth. Business investment and export demand remain decidedly weak. While job creation has firmed since the early months of 2014, significant imbalances remain in the labor market, manifested most notably by the lowest labor force participation rate since the mid to late 1970s. While partially a demographic phenomenon, it is baffling how little cyclical recovery there has been in labor force re-entry, especially in light of much-improved employment growth.
Problems aside, the U.S. economy is the relatively strong player in a weak world, a salient feature of the current dynamic that has been a key driver of a number of significant market adjustments. The sharp appreciation of the dollar along with a veritable plunge in the spot price of oil is the latest in a long string of post-crisis rebalancing events that add another layer of both challenge and hope for a frustrated world seeking to return to economic strength and stability.
Markets Seek World Balance
As shown in Figure 1, the decline in the spot futures price of oil beginning in July 2014 was the most dramatic since the acute phase of the global financial crisis in 2008 and 2009. Between June 2014 and January 2015, the spot price fell from $105.15 to $47.33, a nearly 55% drop, before stabilizing and rising modestly to $59.37 by May.
Sharp as the oil price decline was, it did not, in a general sense, come as a surprise. Supply and demand fundamentals suggested the need for markets to rethink pricing. Oil supply is on the rise, catalyzed to some extent by much-improved U.S. energy policy. A less than stellar global economic recovery, shown in Figure 2, has constrained demand.
Equity markets in the U.S. and around the world initially viewed the oil price adjustment as a negative in spite of the obvious benefits to consumers and the inflation picture. Such a counterintuitive reaction was likely rooted in growing fears regarding the risks of broad deflation in the post-crisis environment. The data in Figure 3 lend some credence to these concerns by showing the path of consumer price inflation in China, the Eurozone, and the United Kingdom. While the world is not yet in deflation, the direction of these data certainly merits attention. As the Japanese experience has shown, deflation, by creating disincentives for consumer and business spending as well as credit extension and borrowing, can often be a precursor to an extended period of economic stagnation.
Central banks around the world have been actively fighting deflation risk. Either as a result of policy intent or derivative policy impact, this has depreciated a number of currencies. In such a climate, the currency of the relatively strong economy, these days the U.S., becomes a portfolio hedge, even though U.S. inflation remains uncomfortably on the low side. As shown in Figure 4, the value of the dollar has responded in kind with an appreciation in the broad nominal metrics, most sharply since the spring of 2014, but really since the middle of 2011.
Figure 5 shows the MAPI Foundation’s forecast for the path of the U.S. dollar against a range of non-U.S. industrialized country currencies as well as an aggregate of developing country currencies. In spite of a still weak-kneed U.S. economy and a Federal Reserve that remains hesitant to initiate a policy normalization process, we expect the dollar to remain the currency of choice for the balance of 2015 before experiencing a measure of retrenchment during 2016. The U.S. economy, with all of its current challenges, remains ahead of other major trading nations in its post-crisis adjustment process and global investors, as a result, are simply favoring the greenback.
Figure 1 – Cushing, OK Crude Oil Futures
Figure 2 – World Real GDP Growth
Figure 3 – Consumer Price Inflation: China, the Eurozone, and the UK
Figure 4 – The U.S. Dollar
Figure 5 – Forecast: U.S. Dollar Versus Industrialized and Developing Country Currencie
The Relatively Strong, Historically Disappointing U.S. Economy
While the U.S. economy has enjoyed relatively consistent growth in recent years, perspective is important. Figure 6, which shows annual U.S. GDP growth from 1970 to 2014, illustrates just how historically weak the path of recovery from the 2008-2009 downturn has been. In the wake of every recession since the 1970s, U.S. economic growth has surged well beyond its sustainable level (in the range of 2.2% to 2.5%). These surges were important for reigniting confidence and the risk-taking that underlies growth-enhancing investment. By contrast, growth since the 2008-2009 crisis has been trend level and no more, creating, at least in a visceral sense, the impression that the gravitational pull of the Great Recession remains.
In the initial stages of the economic recovery, which began in the summer of 2009, the U.S. manufacturing sector was the strong player in a weak picture. But subsequently, the factory sector just could not escape the challenges of a still-troubled world. As shown in Figure 7, U.S. manufacturing suffered an output contraction during the first quarter of 2015, the first since the second quarter of 2009. While difficult winter weather and the work slowdown at the Western ports played a role, the output decline also came as a result of more fundamental factors such as the elevated dollar, weak global demand, and the negative impact of the oil price plunge on energy investment. Data for April and May suggest that manufacturing output may very well contract in the second quarter of 2015 as well. Certainly, the weakening export picture (Figure 8) and the sluggish capital investment picture (Figure 9) are not exactly positive omens for the strength of U.S. manufacturing growth over the short term.
The housing rebound has been moderate and the pace of recovery in the new single-family home market, shown in Figure 10, does not really suggest that the residential sector will be a catalyst for manufacturing performance. Output growth in wood products and furniture has been at best uneven since December 2014, although electrical equipment and appliances output growth has been somewhat stronger and more consistent.
Nonfarm payroll growth, shown in Figure 11, is the one unequivocally bright spot in a muted U.S. economic environment. The six-month moving average of net gains in nonfarm payroll employment has been consistently above 200,000 since February 2014 and was above 250,000 between November 2014 and April 2015 before moderating to 236,000 in May 2015. Job creation in the manufacturing sector, shown in Figure 12, has exceeded the expectations of many but has been below 10,000 per month since January 2015 in the face of weak global demand, a strong dollar, and weather-related challenges. Clearly, however, strong factory output growth will give rise to at least a decent pace of job creation in U.S. manufacturing even in a period of rapid new technology deployment and accelerated process innovation.
While the picture is brighter, labor market challenges abound. At 59.4%, the employment-to-population ratio remains where it was in June 2009 when the recession reached a trough, a historically unusual occurrence for a metric that normally recovers as the economy does.
Labor supply is problematic. Figure 13 shows the dramatic fall in the labor force participation rate that began around 2000, well before the financial crisis. As of late, there have been signs of a modest acceleration of labor force re-entry, but the participation rate remains at its lowest levels since the late 1970s. A mixture of demographic and economic forces is at work, adding an element of job market stress not normally seen in the wake of previous recessions.
The MAPI Foundation’s forecast calls for modest economic performance in the United States. We expect U.S. GDP growth to accelerate from 2.4% in 2015 to 3% in 2016 before moderating to 2.7% in 2017. With employment growth expected to stay relatively healthy, consumer spending growth is projected to exceed GDP growth at 3.2% in 2015 and 2016 and 3% in 2017.
The key drivers of manufacturing demand are expected to remain constrained by less-than-stellar U.S. and global economic conditions. Equipment spending growth is forecast to be moderate, accelerating from 6.1% in 2015 to 9.6% in 2016 before moderating to 6.1% during 2017. In the face of weak world demand and an elevated dollar, export growth has a sluggish outlook, expected to accelerate from 1.5% in 2015 to 4.5% in 2016 and 4.3% in 2017. As a result, manufacturing output growth is expected to be constrained, at 2.5% in 2015, 4% in 2016, and 3.1% in 2017.
In spite of accommodative monetary policy, consumer inflation (excluding volatile food and energy prices) is expected to remain on the low side at 1.7% in 2015, 2.1% in 2016, and 2% in 2017.
Figure 6 – U.S. Real GDP Growth
Figure 7 – U.S. Manufacturing Production Growth, Seasonally Adjusted at Annual Rate
Figure 8 – U.S. Total Export Growth, Seasonally Adjusted at Annual Rate
Figure 9 – U.S. Equipment Expenditure Growth, Seasonally Adjusted at Annual Rate
Figure 10 – U.S.: Total New Single-Family Homes Sold, Seasonally Adjusted at Annual Rate
Figure 11 – Total U.S. Nonfarm Job Creation, Thousands
Figure 12 – U.S. Manufacturing Job Creation, Thousands
Figure 13 – U.S. Labor Force Participation Rate
The Pull of Weakness in a Troubled Eurozone
Modestly improved data aside, pervasive weakness continues to define the Eurozone economy. Figure 14 shows the three-month moving average of aggregate Eurozone manufacturing production growth, which has vacillated from positive to negative with little conviction on either side. Real (inflation-adjusted) GDP growth in the monetary union has either been sluggish or contracting. Growth averaged 1.2% between the first quarter of 2014 and the first quarter of 2015 and has been below 2% since the first quarter of 2011.
The geographic composition of activity is of recent interest. Figure 15 shows somewhat waning growth in Germany, the largest and normally strongest economy in the Eurozone. On a year-over-year basis, growth slowed from 2.3% during the first quarter of 2014 to 0.95% during the first quarter of 2015. By contrast, as shown in Figure 16, notable improvement has been seen in the Spanish economy, the fourth largest in the Eurozone. Spanish growth accelerated consistently from 0.67% during the first quarter of 2014 to 2.9% during the same period.
The region is plagued by numerous risks, most notably the outcome of talks to resolve the growing debt problem with Greece. Figure 17 shows the broad deflation risk for the region. The rise above the zero line from modest deflation to modest inflation is a welcome relief, however temporary. Arguably, it has been partially catalyzed by the European Central Bank’s efforts with quantitative easing.
Activity in the geographic and trade proximity of the Eurozone has been mixed. As shown in Figure 18, manufacturing growth in the key Eastern European economies of Poland and the Czech Republic has been moderate, although moderating as of late. Economic growth in the United Kingdom, which has a significant trade relationship with the Eurozone, has been slowing appreciably. From 3.6% during the first quarter of 2014, UK GDP growth decelerated consistently to 1.2% during the first quarter of 2015.
Figure 14 – Eurozone Manufacturing Production Growth, Three-Month Moving Average
Figure 15 – Germany: Real GDP Growth
Figure 16 – Spain: Real GDP Growth
Figure 17 – Eurozone: Consumer Price Inflation
Figure 18 – Poland and the Czech Republic: Manufacturing Production Growth
Is Russia a Crisis in the Making?
Due very much to its own belligerent actions and the resulting rejection of global investors, Russia is at risk for a short-term, destabilizing crisis. As shown in Figure 19, Russian economic growth contracted by nearly 2% during the first quarter of 2015, the first GDP contraction in that troubled country since the fourth quarter of 2009. In a sign of waning confidence, gross fixed capital formation growth has been on an increasingly consistent and deepening decline since September 2012.
Figure 20 offers a picture of what was effectively a crash in the Russian currency between June 2014 and January 2015. There has been subsequent stabilization, although the ruble is likely to come under pressure once again as the recession persists and deepens. In spite of the dramatic currency weakening, export growth has also been on an increasingly deep downturn, partially due to the collapse in oil prices but more broadly symptomatic of an economy that is suffering from self-inflicted wounds. Between November 2014 and April 2015, the contraction in exports averaged nearly 27%.
Figure 19 – Russia: Real GDP Growth, Year Over Year
Figure 20 – U.S. Dollars per 100 Russian New Rubles
The Western Hemisphere: Weakness Versus Hope
Canada and Mexico are realizing the benefits of U.S. growth and the strains of world weakness. Figure 21 shows that the Canadian economy suffered a modest 0.6% contraction during the first quarter of 2015, the first contraction since the second quarter of 2011. The contraction of U.S. manufacturing in the early months of 2015 hurt Canada as a supplier of intermediate inputs to the U.S. factory sector. As a commodities exporter, the Canadian economy is also negatively affected by lingering global troubles. Figure 22 shows weakness in domestic Canadian demand. Capital investment was negative in the fourth quarter of 2014 and the first quarter of 2015, while consumer spending growth slowed to an average of 1.3% during that period.
Figure 23 shows that Mexican GDP growth has been strengthening modestly in recent quarters. Growth averaged a moderate 2.6% during the fourth quarter of 2014 and the first quarter of 2015, a marked acceleration from the sluggish 1.8% average of the prior four quarters. Firming manufacturing output growth, shown in Figure 24, might foreshadow modestly improving GDP growth performance over the short term.
Figure 25 shows a Brazilian economy that is in trouble, partially as a result of global weakness and partially due to policy failures. GDP growth in the largest developing economy in the Western Hemisphere contracted in the four quarters between the second quarter of 2014 and the first quarter of 2015. A deepening manufacturing contraction, shown in Figure 26, suggests that a positive turn for Brazil is not yet in sight. While forecasters are predicting a very modest rebound in Brazilian manufacturing growth during 2016, the outlook for the industrial sector throughout Latin America remains sluggish and uncertain.
Figure 21 – Canada: Real GDP Growth, Seasonally Adjusted at Annual Rate
Figure 22 – Canada: Real Consumer Spending and Real Capital Spending Growth, Seasonally Adjusted at Annual Rate
Figure 23 – Mexico: Real GDP Growth
Figure 24 – Mexico: Manufacturing Production Growth
Figure 25 – Brazil: Real GDP Growth
Figure 26 – Brazil: Manufacturing Production Growth
The Shifting Economic Balance in Asia
A troubled world economy that is hoping for a bottom in China’s protracted economic slowdown is at best seeing only hints of it. Export demand contracted between March 2015 and May 2015, while import demand growth was in negative territory between November 2014 and May 2015. Fixed asset investment data, shown in Figure 27, is sending mixed signals. While overall investment growth is continuing its rather sharp deceleration, with growth being cut nearly in half between May 2013 and May 2015, a clear bottom has appeared in the deceleration of investment in equipment and tools, suggesting a measure of stabilization in business confidence.
As shown in Figure 28, the slowdown in manufacturing output growth appears to have reached at least a temporary bottom in March 2015 at 5.6% growth on a year-over-year basis, with a subsequent acceleration to 6.1% growth by May. The data extending back to 2009 show a number of these “temporary” bottoms and the outlook for manufacturing in China should be viewed with caution.
Figure 29 shows a somewhat clearer picture for Japan, which recovered quickly from its most recent recession. The composition of the growth rebound is encouraging. While part of the recovery was catalyzed by a weaker yen, which stimulated somewhat stronger, if recently waning, export activity, Figure 30 shows a welcome surge in gross fixed capital formation growth, from 1% in the fourth quarter of 2014 to 11% in the first quarter of 2015. Manufacturing output growth, shown in Figure 31, is still struggling to recover and will likely do so if export and investment growth remain positive.
The world has been carefully watching India in the wake of the transformational political shift that took place in May 2014. Early signs suggest that the Indian economy may start to grow faster than the Chinese economy, a historic shift for Asian economic dynamics. Figure 32 shows that while output performance has been volatile as of late, the worst of a sharp slowdown has passed. Growth bottomed at 5.3% during the first quarter of 2014 before accelerating to 8.4% by the third quarter and then moderating to 6.1% by the first quarter of 2015.
Figure 33 shows a marked deceleration of consumer price inflation, encouraging for the strength and stability of the outlook. Lower energy prices as well as higher confidence in the management of monetary policy have played a role. If sustained, a more stable price picture would buttress a wide range of growth-enhancing factors, including consumer spending and business investment. With a somewhat brighter macroeconomic picture at hand, Figure 34 shows more consistently positive manufacturing output growth, which averaged a moderate 4.2% between November 2014 and April 2015.
Figure 27 – China: Fixed Asset Investment, Overall and Equipment and Tools
Figure 28 – China: Growth of Industrial Value-Added
Figure 29 – Japan: Real GDP Growth, Seasonally Adjusted at Annual Rate
Figure 30 – Japan: Real Gross Fixed Capital Formation Growth, Seasonally Adjusted at Annual Rate
Figure 31 – Japan: Manufacturing Output Growth
Figure 32 – India: Real GDP Growth
Figure 33 – India: Consumer Price Inflation
Figure 34 – India: Manufacturing Production Growth
Global Forecast and Final Thoughts
Figure 35 shows the MAPI Foundation’s forecast for aggregate non-U.S. industrialized economy growth as well as aggregate developing country growth. World economic gains are expected to remain sluggish through the end of 2016. Aggregate growth in the advanced economies outside of the U.S. is predicted to be only 2.3% by the fourth quarter of 2016, significantly below the 3% to 3.5% range that is the norm for a period of global expansion. Similarly, developing country growth is expected to reach only 4.5% by the end of 2016, well below the normal range of 5% to 5.5%.
With weak non-U.S. global growth and global deflation jitters likely to persist through 2015 and at least part of 2016, the strong dollar / weak oil combination will frame world economic developments over the short term. For the time being, global challenges will remain a headwind to strong and stable U.S. manufacturing growth.
Figure 35 – Forecast: Industrialized and Developing Country GDP Growth Rates