Time to forget the UK referendum effect and look at the big picture, writes Stephanie Flanders
Financial markets are like small children. They find it hard to focus on more than two things at once.” That is the conclusion drawn by one of my colleagues after a lifetime of professional investing.
Whether small children can focus on anything at all is a matter for debate. Chocolate, perhaps. But he has a point when it comes to global markets. Investors have been so focused on the Brexit vote and its aftermath that they have missed the big picture, which is that the global economy is still worryingly dependent on US growth and the extreme efforts of central banks.
There was a fear, in the days after the EU referendum, that Britain’s troubles would sink the global recovery. But investors have decided that for stocks and bonds this shock is actually a win-win. Why? Because growth will not be much affected outside the UK, but central banks will keep monetary policy looser than it would otherwise have been, just to be safe. That explains why stock markets are reaching new highs, even in the UK, and long-term interest rates are lower in most countries than they were on June 23.
This time last year, the obsession was China and the mood was rather different. Stock markets, you will remember, fell around the world when the Chinese authorities announced a surprise depreciation of the renminbi against the dollar. The fear was that a deflating Chinese economy would export its falling prices to the rest of the world via a lower exchange rate and take another bite out of growth in emerging markets.
Funnily enough, the Chinese currency has been falling again recently — by 3 per cent against the dollar in the past three months. That is bigger than the fall last summer but no one seems to care at all. It would be nice to believe that this was because the world is in a stronger position to cope with a deflationary China than a year ago. I fear it is because investors simply have not been paying attention.
It is true that this depreciation feels somewhat more controlled. What spooked investors about China last summer was the feeling of chaos — the mixed messages about the renminbi and the frantic moves to prop up the domestic stock market all had a whiff of panic. If the authorities could not achieve a smooth transition for the exchange rate, how were they going to deliver one for the broader economy?
It feels different this time because those in charge have a plan, and the currency is supposedly now linked not to the dollar but to a broader basket of currencies known as the China Foreign Exchange Trade System. But anyone who has been watching closely would have noticed that the authorities only follow the new system when it allows the renminbi to fall. When the CFETS was rising against the dollar in the first part of the year, the Chinese currency did not rise with it. The net result is that the renminbi is nearly 6 per cent weaker on a trade-weighted basis than it was at the start of the year.
On the surface, China’s economy does look less scary than it did a year ago. The authorities, though, are using the same tools to support growth that they used in the past — public investment and subsidised credit. Fixed asset investment by state-owned companies grew by more than 20 per cent, year on year, in the past three months.
Big picture: China might be more stable but is no closer to resolving its structural and financial imbalances than it was a year ago, and it is still exporting disinflation to the rest of the world via a weaker exchange rate. US import prices from China fell by 3 per cent in June, the largest monthly drop since 2013.
The US can probably shrug off this imported deflation because domestic prices — and, finally, wages — are picking up as the domestic consumer-led recovery continues. Globally, however, the picture is not nearly as strong. The International Monetary Fund’s forecasts, released last week, show global consumer inflation for advanced countries at just 0.7 per cent in 2016. The central banks in the US and the UK are the only ones in the developed world that are expected to achieve inflation at or above the targeted 2 per cent by 2017.
Those new IMF forecasts are helpful, not because they are likely to be right, but because they let us step back from the day-to-day stories to see how global growth expectations have changed over time. At 3.1 per cent, the new growth forecast for 2016 was only slightly lower than the April number. This was taken as more evidence that the negative effects of Brexit are likely to be centred on the UK. But a year ago the fund was expecting global growth this year to be 3.8 per cent, and growth for the advanced economies to be 2.4 per cent. Now its best guess is for growth of 1.8 per cent in those countries — not just in 2016 but in 2017 as well. The forecast for world trade has also been slashed, yet again. We have now had six consecutive years when world trade has been flat or falling as a share of global gross domestic product.
None of this suggests that the global recovery is about to grind to a halt. It does remind us that the world is expecting an awful lot of the US right now, and an awful lot of its central bank. The US has managed a respectable recovery, despite a deeply needy global economy and an unhelpful rise in the dollar. Investors are betting that this can continue, despite the dysfunctional cacophony coming out of the party conventions. We should all hope they are right. The world does not have a plan B.
The writer is chief market strategist for Europe at JPMorgan Asset Management
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