Growth is slowing and the signs are everywhere. After an initially optimistic forecast for 2015, the IMF reined in its projection in January, cutting its outlook by 0.3% to 3.5%.
The latest batch of high frequency economic data released during the first quarter of the year was disappointing, especially regarding growth in the US economy – a key pillar upon which the IMF constructed their optimistic forecast for 2015.
It seems that the IMF may again need to lower its sights. But how did we get here?
The start of 2014 saw frigid Arctic air gripping most of the US with ice storms and snowstorms causing massive disruption and many missed workdays. As a result, US GDP growth dropped by 2.1% in Q1 2014.
The economy did rebound in the following two quarters, growing 4.6%, and 5% respectively, and prompting many professionals to predict continued rapid growth in 2015. However it slipped back in Q4 to 2.2% and has started 2015 off in even slower fashion.
Despite the rapid rebound in mid-2014, GDP growth for the year averaged only 2.4%, no better than the pre-crisis average over the previous 5 years.
Growth in Q1 2015 will probably be even slower – less than 1.5%. Here’s why:
- Manufacturing activity has slumped causing significant pain for the business sector. The regional economic production indexes have stalled. All of the indexes, including the national ISM Index, have been declining (Philadelphia, Empire State) and some precipitously (Dallas, Richmond, and Kansas City). Actual industrial production has declined 0.5% in the past 3 months. Similarly, factory orders have declined in three of the past four months.
- Weak industrial output has coincided with the significant appreciation of the dollar. Its strengthening against virtually all important counterparties has eroded US international competitiveness. Once the effects from the drop in oil prices washes through the trade data, the appreciating dollar will begin to widen the trade deficit later this year, it will be a negative for GDP growth.
- Fiscal spending has been flat for several years due to the gridlock between political parties in Congress and the recent shift in the composition of Congress towards conservative values. As a result of the political stalemate and expected quagmire, this important sector of the economy is likely to continue to be a significant drag to overall economic growth.
- Business investment is also not accelerating. Monthly factory orders have been in decline for the past 4 months, implying that businesses are not presently addressing needs to enlarge their operations.
- Payroll gains slowed dramatically in March after months of very steady large increases. This could be monthly volatility, or the beginning of a more significant slowdown in new job creation reflecting the downbeat character of the monthly industrial data.
- Personal consumption has also eroded. In the past three months real spending has increased by just 0.5% at an annualised rate. And, monthly retail sales have decreased in each of the past three months. Since real consumption accounts for almost 70% of GDP, it indicates a massive deceleration in total economic growth.
- In contrast, personal income growth has continued to expand at a healthy pace, but if non-farm payroll growth remains below trend, then it too will slow and reduce consumption potential.
- Consumer confidence remains close to a cycle high, but it too will depend on the future of payroll growth. Continued below-trend payroll growths will likely damage confidence, and therefore, undermine spending further.
- The growth dividend from lower oil prices has not kicked in. Perhaps, because the previous rapid buildup in shale and other energy sources’ investment has been dulled by the dramatic drop in oil prices; and that this negative impact on employment has offset the positives from oil price reduction on consumption.
Beyond the US, Japan and the EU have accelerated their policy support for their respective economies. However, after 6 months of aggressive QE, little actual growth has resulted.
Both economies are stagnant and both are in the grip of deflation.
Yes, their currencies have depreciated significantly and eventually that should improve their external trade competitiveness. Yes, too, oil prices for these oil import-dependent economic regions have fallen and improved their current account surpluses, but cheaper oil has not contributed to internal GDP growth.
So what now for economies in Asia?
Conventional wisdom among economists, who wanted to be right about China’s economic growth, has always been to predict whatever growth the government says it wants.
That wisdom may still be true in 2015, but the real economic growth rate may be far lower than the announced one, just as 5 to 10 years ago it was always greater than announced.
Recent high frequency data from China indicates that industrial production is diminishing, especially in the big iron and steel making industries as demand for infrastructure projects from local jurisdictions have plunged.
No new funding from Beijing and ongoing corruption investigations have led to a significant reduction in demand and in output.
Consequently, for the rest of Asia (ex-Japan) the impetus for economic growth will not come from manufacturing and exports to send to developed countries, or to China.
Growth will have to come from internal sources and that implies significantly less growth than in the past.
Singapore is a good example of an open economy suffering from diminished demand for its exports.
Here industrial production growth has shrunk and Q1 2015 GDP growth is estimated to be flat, implying that the government’s growth target for this year will be very hard to achieve.
Reflecting this uncertainty and doubt, financial markets in the US have turned flat in the past few months.
For example, while the stock market has appreciated 1.6% this year, nearly all of those gains were in the first few days of the year. Since its peak in early March it has declined 1.2%.
The Treasury yield curve has stopped flattening recently. The yield curve traditionally flattens on expectations of the Fed tightening policy by raising short-term interest rates. The curve did flatten significantly at the end of last year when market participants were universally predicting that the Fed would soon begin raising interest rates.
The stability in the yield curve over the past few months reflects a shift in expectations toward uncertainty and a postponement of the anticipated tightening. The bond market now expects only one tightening this year and for that to occur in October.
On foreign exchange markets even the dollar has begun to retreat from its rapid appreciation over the previous six months.
Traders who had believed that US interest rates would rise immediately and favor the greenback have tempered their enthusiasm as it now seems that the Fed will be much more cautious in raising its official rate this year.
Consequently the dollar will probably be trendless for a while before resuming its appreciation later in the year.
All the financial markets in the US are responding to the recent weakening in high frequency economic data, signaling that current and near prospective economic growth do not warrant an immediate monetary tightening, nor higher stock market valuations.
Therefore, the Fed’s long signaled interest rate rise will likely be delayed, and the trajectory of their subsequent rate increases will be much shallower than originally anticipated.
The implications for the rest of the world’s developing economies, including China’s, is that there will be smaller external demands for their exports than previously thought, and that they will need more fiscal and monetary stimulus to boost internal growth.
This article originally appeared in the CAMRI Global Perspectives: Monthly Research Digest series, published by the Centre for Asset Management Research and Investments at NUS Business School.