THE MARKETS have been in turmoil since the beginning of the year. Speculative outflows from many emerging markets have intensified, at a time when growth in most advanced economies is still frail and insecure. Equities suffered their worst January in five years. Wall Street and most European markets recorded net falls of 5-10% from their recent highs.
It is too early to talk about a bear market, defined as falls in excess of 20%. Except in Tokyo, where prices fell by some 14%, recent falls cannot even be seen as a “correction”, ie, net falls of 10-15%. The markets have become brittle, and there are concerns that new threats could endanger the global economy. But our central scenario still points to modest global growth continuing over the next 12 to 18 months, albeit with occasional setbacks. A new recession is unlikely and the short-term outlook remains relatively benign. But this should not lull us into a sense of false complacency. Fundamental longer-term problems persist in most major regions and are still not being addressed. New risks may resurface without much warning.
Recent nervousness has been mostly linked to tapering by the Federal Reserve, and to signs that Chinese growth is slowing. But this is unlikely to produce a market rout.
From the Fed’s perspective, tapering is progressing smoothly. The $85bn (£50.9bn)original monthly level of asset purchases was cut in two $10bn instalments, to $65bn, and further gradual reductions can be expected in spite of mixed economic indicators.
Fed purchases, and Japan’s massive QE, estimated at some $58bn per month, are still adding significantly to global liquidity. But the perception that the Fed is moving gradually towards a less expansionary stance will remain a powerful factor restraining excessive market exuberance, at a time when there are signs that growth in the two largest economies – the US and China – is losing some momentum.
Chinese growth slowed to 7.7% year on year in the fourth quarter of 2013, from 7.8% in the third quarter. Full-year Chinese growth in 2013 was also 7.7%, the same as in 2012, but the lowest since 1999. Many market traders are worried about China’s slowdown. But it is important to remember that bringing down medium-term growth to 7% is a major policy aim of the Chinese authorities, as part of their strategy of rebalancing the economy.
The aim is to move away from undue reliance on investment to a more sustainable growth model in which domestic consumption will play a more significant role. China’s current debt problems are due to wasteful and unproductive over-investment, and moving gradually to lower growth is necessary. There is always a risk that the slowdown would be too abrupt. But with annual inflation down to only 2.5% in December 2013, the authorities have adequate tools at their disposal to counter the threat of a hard landing. Our full-year forecast for Chinese GDP growth in 2014 is 7.2%, slightly below the consensus.
The US recovery is mediocre by historical standards, but growth is stronger than in most other advanced economies. The robust housing market, which underpins consumer confidence, remains a main driver of the US upturn. Home prices rose 13.7% from a year earlier in November 2013, the biggest 12-month increase since February 2006.
But US labour market figures were much weaker than expected. The economy created only 113,000 new jobs in January, after 74,000 in December, the second month in a row that the figure has been disappointing. Although the unemployment rates fell to 6.6%, the lowest since October 2008, US job creation has clearly been inadequate in recent months. But US real GDP grew at an annualised rate of 3.2% in the fourth quarter of 2013, below the 4.1% growth recorded in the third quarter, but better than expected.
Full-year US growth in 2013 was 1.9%, lower than in 2012 but much stronger than in the eurozone, where GDP recorded a full-year decline of 0.4% in 2013. Given the relatively solid pace of US expansion, with full-year GDP growth expected to accelerate to 2.8% in 2014, the Fed is right to persevere with its current policy of scaling back asset purchases at a steady pace of $10bn per month. The budget agreement in Congress between the Democrats and the Republicans is incomplete, but if it is upheld, it will improve confidence in the coming months.
The eurozone economy has returned to growth in recent months, even though GDP fell in 2013 as a whole. The January purchasing managers’ surveys have signalled a fast pace of expansion. But the outlook is still very uncertain. Eurozone retail sales fell sharply over the Christmas period, with their biggest monthly fall in two and a half years. December sales fell 1.6% compared to November, and were 1% lower than in December 2012. The largest annual fall was in Germany, where retail sales were a hefty 2.4% lower than a year ago.
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Eurozone annual inflation fell to 0.7% in January, well below the official target of “just under 2%”, adding to fears of deflation. But the ECB was right not to rush into a further cut in its official rate, below its already very low level of 0.25%. ECB policy will remain expansionary, but with unemployment stuck at 12% and GDP full-year growth likely to improve to only 1% in 2014, the main challenges facing the eurozone are supply side reforms and better policy coordination.
Britain’s recovery remains solid. GDP grew by 0.7% in the fourth quarter of 2013, slightly below third-quarter growth. Full-year 2013 UK growth was 1.9%, the same as in the US but higher than in all the major eurozone economy, including Germany and France. UK annual inflation fell to its 2% target, and the labour market is strong. But this good news is creating problems for the MPC. With the unemployment rate down to 7.1%, just above the 7% “forward guidance” threshold, monetary strategy will have to evolve. It remains to be seen if the MPC has done enough in February to restore credibility.