The Global Economy: Where Next?

The global growth slowdown has not gone unnoticed. To drum up coordinated support for global growth, the IMF raised the issue during its recent spring meetings—unfortunately, however, it has little ability to bring forward a coordinated effort to support growth. Non-central bank policymakers believe that a further loosening of monetary policy is counterproductive. The scope for a combined fiscal effort is limited by coordination problems, and only very few countries have the required fiscal space to engineer a meaningful fiscal impulse. Although quite in line with the signals from our proprietary lead indicators, I am surprised about how the loosening of financial conditions over the past eight weeks or so has resulted in little improvement in the growth and sentiment data. Looking ahead, the signals from our lead indicators remain weak—more in line with an economy that is moving sideways to marginally higher than one powering back.

In the absence of negative news, the path of least resistance seems to be for risky assets to continue to perform. If growth remains muted, there is little reason for global central banks to spoil the party. Headline inflation will likely move higher given the rally in commodity prices, but given muted levels of growth, I doubt that a commodity-induced increase in headline inflation will nudge policymakers meaningfully toward tightening the stance of monetary policy. Against this backdrop, yield products continue to look appealing. Emerging market currencies in particular seem to be in a sweet spot as they offer a yield and that domestic EM economies are benefiting from a more benign capital flow picture. A number of challenges remain, however.

First, despite the recent easing in financial conditions, growth could continue to drift lower. Monetary policy is already stretched, so it will be difficult to engineer an appropriate response to a further deceleration in growth. In this context, the impact of the recent increase in commodity prices must be monitored.

Second, given the benign trajectory for the federal funds rate implied by the U.S. yield curve, the market is vulnerable to any pickup in inflation that would force the Federal Open Market Committee to accelerate the pace of monetary policy normalization. A pickup in inflation would be doubly challenging for the markets as the policy response would take place amid a backdrop of weak global growth. Although the recent rise in commodity prices could put pressure on headline inflation, weak global growth should keep core inflation pressures at bay.

Third, Britain could vote to leave the European Union (EU). Concerns over the impact of this will weigh on growth both within the UK and in the bloc as a whole. Comfortingly, opinion polls (for what they are worth) have recently indicated that the likelihood of Britain voting in favor of leaving the EU has fallen.

Fourth, concerns about growth and financial stability in China could return quicker than expected. Given the fiscal push that the authorities have applied to the economy, the China worries appear more likely to resurface in the second half of the year.

2016-GL-3931

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