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Secular stagnation and low inflation

Our central scenario for the global economy remains one in which growth is below trend. Whilst the Federal Open Market Committee (FOMC) is debating the first increase to US rates after seven years and the view that the US economy is strengthening is gaining traction, the global economy will not build sufficient velocity in all key regions. Inflation may well remain subdued and, as a result, the trajectory of interest rates is likely to remain shallow.

Marcel Porcheron
16 September 2015

A number of indicators now suggest that the US economy may be returning to improved health, as annualised real GDP figures are expected to show growth at 3.7% (Deutsche Bank forecast) compared to a long-term trend of 3.5%, and just 2.2% since the end of the last recession.

Jobless claims are at decade lows and the US unemployment rate, running at 5.1%, suggests that the US labour market is tightening. Yet wage inflation remains stubbornly low. As we have previously highlighted the Federal Reserve has already adjusted down their estimate for NAIRU, the rate at which unemployment would trigger wage inflation. Meanwhile both part-time employment and long-term unemployment are high, which might suggest that the output gap is weighing on growth and wages. Nominal wage growth (before adjusting for inflation) is thought to be around 2%. Whilst numerous variables might contribute to this low figure, including demographic trends within labour markets and reduced bargaining power of labour globally, domestic inflation could remain low in spite of a stronger US labour market.

Any improvement in the US economy may not be of immediate benefit overseas. US imports of $2.3 trillion annually are equivalent to 16% GDP, which is a lower ratio than developed world peers in Europe and Asia. China heads the US’s major trading partners. It accounts for 20% of imports and has seen factory gate prices declining. The authorities have also begun a move to a floating rate currency, which could well see export prices fall. Amongst the major imports to the US is oil, where prices remain depressed, limiting the receipts for overseas countries importing to the US for the time being. Whilst Japan accounts for just 6% of US imports, this is equivalent to 20% of Japanese exports and so the country may be one beneficiary of a return to stronger US growth should it materialise. Whether the benefits will make their way out of the Japanese corporate sector and manifest in higher inflation remains debateable.

A stronger dollar could well be one effect of a firmer US economy, particularly if the US continues to outpace peers. Globally, central banks have been in an accommodative mode and Japan, Eurozone and China are engaged in policies which have the effect of depreciating their currencies. Dollar strength in the past has brought with it successive crises outside of North America, and emerging markets with dollar debt and rapidly declining reserves look vulnerable. This too may have the effect of slowing global growth.

The US is supported by a domestic banking system that has gone some way towards resolution of its excesses from the previous crises, in particular in recognising loan losses against assets. As a result, bank lending and the availability of credit has improved. Meanwhile, the state of the banking system in Europe remains moribund, where bank lending growth rose by less than 1% nominal and total lending remained flat, as highlighted by The MacroStrategy Partnership LLP on Friday. The average of total bank assets in the UK and Europe is in excess of 350% GDP and banks are of much greater relative importance than their US and even Asian peers. This suggests that a recovery in European growth is likely to be several years behind the US.

Secular stagnation graph

Source: The MacroStrategy Partnership LLP

Conclusions

Even if the US does recover, global growth in aggregate may not follow. Europe seems unlikely to provide a positive surprise and China is slowing, having previously accounted for a significant portion of global GDP. Weak revenues in the most recent US earnings season, a downbeat outlook and poor results from cyclical sectors are signals that the global economy is impaired. Against this backdrop, it may be unlikely that investment picks up to support further growth, particularly since debt levels are high; the cost of debt servicing would increase with a higher rate cycle.

Look out for an update from us following the FOMC decision.

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Risk warning

The value of investments, and the income derived from them, can go down as well as up and you can get back less than you originally invested. This article does not constitute personal advice. If you are in doubt as to the suitability of an investment please contact one of our advisers. Past performance is not a guide to future performance. Different funds carry varying levels of risk depending on the geographical region and industry sector in which they invest. You should make yourself aware of these specific risks prior to investing. We aim to provide investors with information to help them make their own investment decisions although this should not be construed as advice or an investment recommendation. If you are unsure about the suitability of an investment or if you need advice on your specific requirements, we strongly suggest that you consider professional financial advice.

 

Sources

MacroStrategy, Centrality of Bank Lending, 10 September 2015

Deutsche Bank Research, US Economic Weekly, 11 September 2015

Permira Debt managers, BOA ML Global Research, Central Bank Data, Haver, February 2014