More Growth, Less Fear: 2013 Global Economic Outlook
Editor’s note: The following is an excerpt of an in-depth economic research report recently published by J.P. Morgan’s Corporate & Investment Bank. To read the complete report, please visit www.jpmorganmarkets.com.
Global growth momentum is building, and we forecast faster growth in the coming quarters. The bar for improvement is not very high as global gross domestic product (GDP) rose at a meager 2.1 percent last year, a percentage point below our estimate of trend. This year growth is projected at a 2.5 percent pace in the first half of 2013, accelerating to a 3.3 percent rate during the second half of the year. If right, the global recovery will mark a turning point in 2013 following two years of subpar performance.
The impetus for stronger growth comes as businesses turn more expansionary. Companies became cautious in 2012 against a backdrop of slowing profit growth and heightened uncertainty about the euro area and China. Spending on business equipment contracted in the middle two quarters of last year (see figure 1). Combined with a slowing in hiring and efforts to adjust inventories, business caution pushed global growth to the lowest pace of the expansion. However, global final demand was supported during this period on the back of continued growth in consumer spending. With profits still expanding and policy actions successful in stabilizing euro area stress and Chinese growth, business sentiment began to lift last quarter. The upturn in sentiment will be amplified by the recent aversion of the worst of the U.S. fiscal cliff.
The anticipated rebound in investment spending and a turn in the inventory cycle points to better times for the beleaguered global manufacturing sector. After stagnating for much of last year, global manufacturing is expected to rise at a 3.5 percent pace in 2013 (4Q/4Q). Asian economies that lie at the center of the global technology and manufacturing cycle will benefit most.
As the year begins, the growth lift will be constrained by two factors. First, the developed market (DM) economies face a large, front-loaded fiscal tightening. In the U.S.an early year drag associated with the expiration of the payroll tax holiday will hold back the economy despite significant private sector healing and improving credit and financial conditions. Our forecast anticipates that a setback in U.S. consumption growth will limit lift in the first half of this year, followed by a return to above-trend global growth during the second half of 2013. In Europe, while we expect fiscal drags to ease some in 2013, austerity will still weigh on growth.
Second, credit conditions are expected to remain somewhat restrictive in Europe and emerging market (EM) economies. A tightening in credit terms and standards was a major factor in the global economy’s poor performance last year. It also helps explain the relative outperformance of the U.S. where credit conditions improved. We believe these drags on the euro area and EM are starting to fade, particularly in the euro area where the European Central Bank’s Outright Monetary Transactions (OMT) program is anticipated to help lift the region out of recession. However, euro area bank deleveraging and the unwinding of easy EM credit in the aftermath of the global financial crisis will take time and is expected to limit the pick up in global growth.
Although growth is expected to quicken, the legacy of two years of subpar performance looms large, creating significant challenges for policymakers.
Although growth is expected to quicken, the legacy of two years of subpar performance looms large, creating significant challenges for policymakers. Global inflation is expected to move lower this year, largely as a result of declining core inflation in the DM. Inflation has proved sticky in some DM economies because of institutional rigidities and well-anchored inflation expectations. A sharp increase in goods price inflation, reflecting previous overheating in the EM economies and strong manufacturing activity, also played an important role. This latter source of inflation is now unwinding, with DM import price inflation forecast to slide to near zero over the coming year. With excess slack persisting, DM inflation is set to fall well below central bank objectives this year.
The projected tension between low underlying inflation and the constraint posed by the zero-interest-rate bound represents a unique challenge for DM central bankers. Aggressive fiscal tightening in the U.S. and Europe in the face of high unemployment represents another. Not surprisingly, institutional and political tensions have escalated amid widespread concerns about the high cost of continued subpar performance on potential output and/or growth, inflation dynamics and debt sustainability. These pressures are particularly acute in Europe and Japan.
DM central banks are responding to these challenges in a number of ways. Central bank balance sheets will expand significantly more. Moreover, there is a major new initiative underway as central banks experiment with communication policy—the signals they send about their objectives and how they will react to changing economic circumstances. The active use of communication policy, with balance sheet activities used to reinforce messages, will be the defining feature of the G-4 central bank landscape in 2013. Recent months already have set the ball in motion. The liquidity backstop provided by the ECB’s OMT program introduced a risk-sharing mechanism that changed the nature of sovereign debt in the region. Last month, the Fed tied its rate guidance explicitly to observable economic conditions in an attempt to augment the perceived diminishing returns of asset purchases. Next up to the plate is the Bank of Japan (BoJ), which is on the cusp of beginning an unprecedented battle against deflation.
In the EM, the recent slow growth phase is, in many respects, a blessing because it has contained inflation in consumer and asset prices. At the same time, this period of subpar growth has exposed underlying vulnerabilities that will take time to resolve. Corporate margins are under pressure as inflation has slowed more than the growth of labor costs. With debt levels elevated and nonperforming loans rising, banks are likely to remain cautious. What’s more, the aggressive actions by G-4 central banks are likely to generate renewed upward pressure on EM currencies, further eroding the competitive position of EM economies. It is unclear whether EM policy-makers can promote a continued rotation in growth toward domestic sources while enacting reforms needed to strengthen their service and financial sectors. While some firming in growth probably would be welcomed, what seems certain is that EM policy-makers will not permit a return of the conditions that prevailed before last year.
The anatomy of two years of subpar growth
Following a sizable bounce in 2010, the global recovery soured. After expanding a modest 2.7 percent (4Q/4Q) in 2011, global GDP looks to have posted an even weaker 2.1 percent last year (see figure 2). At the start of each of these years, our year-ahead outlook highlighted growth constraints coming from ongoing private sector deleveraging, a broad-based need to adjust public finances, and the European sovereign crisis. However, the outlook also anticipated support from accommodative global monetary policies, healthy EM expansion, and the normalization of depressed levels of activity in the developed economies.
Figure 2: Real GDP
%4q/4q for full years, qtrly avg for half years (trend growth in parentheses, %)
|Euro Area (1.3)||2.2||0.6||-0.6||0.4||1.4|
|EM Asia (6.8)||8.5||6.8||6.3||6.6||6.9|
|EM Asia ex China (5.1)||7.0||4.2||4.9||4.5||5.1|
|Latin America (3.8)||5.7||3.2||2.6||4.0||3.9|
|EMEA EM (3.7)||3.9||3.9||1.5||2.5||3.3|
In the event, our forecasts proved too optimistic. During 2011 it was reasonable to attribute part of the slowdown to a set of temporary natural disasters and geopolitical developments—surging agricultural and oil prices, the Tohoku earthquake and Thai flooding—which squeezed household purchasing power and disrupted global supply chains. However, as these forces faded, global growth slowed further.
The euro area was an important source of the global economy’s woes last year. The combination of the region’s slide into recession and deleveraging by euro area banks directly contributed to slower growth across the globe. The systemic threat the region’s crisis posed to global financial stability also weighed on confidence and global asset prices, further dampening demand.
Without downplaying the importance of the crisis, the euro area was not the sole factor explaining global growth weakness in 2012. Indeed, relative to the expectations held at the start of the year, euro area growth was in line with our forecast. The euro area crisis needs to be linked with two related factors to explain last year’s weak growth outcome.
The Euro area was not the sole factor explaining global growth weakness. Indeed, Euro area growth was in line with our forecast.
- EMERGING MARKET CREDIT CYCLE TURNE DRESTRICTIVE. Each large emerging market economy grew well below trend in 2012. While there are unique characteristics to the growth disappointments in China, Brazil, India and Russia, the turn toward tighter credit conditions was common across the EM. Rapid credit growth in 2010 and 2011 restored a trend interrupted briefly by the global financial crisis and pushed the credit-to-GDP ratio in all three EM regions to new highs. However, a series of developments during the second half of 2011 caused banks to turn more cautious. EM central banks began to tighten policy to combat overheating in their economies and asset markets. In addition, the intensification of the European debt crisis caused Economic and Monetary Union (EMU) banks to pull back from the emerging markets. This effect was magnified by a global investor flight from risk that produced a sharp drop-off in net capital flows to the EM. Finally, slowing global growth produced deterioration in corporate performance and an increase in nonperforming loans. These supply-side developments contributed to a severe slowdown in the growth of EM domestic credit to about 15 percent over a year ago, the weakest pace since late 2002, aside from the 2008–09 recession, although demand-side factors also played a role.
- U.S. CORPORATES TURNED CAUTIOUS. While EM corporates faced tighter credit conditions and narrower profit margins, U.S. corporates generated better performance over the past year. Corporate profits continued to rise, lifting margins to near record levels. Financial conditions continued to ease, as did bank lending standards. Still, the U.S. economy slowed into midyear as businesses turned cautious. Following two years of strong growth, business capital spending slowed sharply during the first half of 2012 followed by a contraction in the third quarter. And private sector job growth flagged during the middle part of last year. This didn’t produce a major disappointment in growth because households lowered their saving rates in the face of weaker income growth. Nonetheless, it served as a reminder that corporate remain skittish and are quick to respond to increased uncertainty or actual shortfalls in demand growth.
Business caution countered by consumer resilience
The previous discussion highlights that much of the shortfall in global growth last year came from a sharp slowing in business activity, reflecting the combination of tighter EM credit conditions and broader concerns about the outlook. Global business spending and hiring growth slowed around midyear and a sense of corporate caution also affected inventory management, above and beyond what would have been expected amid the climate of sluggish final demand growth. The pullback in business demand resulted in a highly unusual lull in manufacturing, which largely stagnated for all of last year.
Against this backdrop, solid gains in consumer goods spending sustained the economic expansion. Global retail sales volumes rose an estimated 3.3 percent in 2012, roughly the same pace as the previous year, although there was significant volatility in spending growth during the year. The resilience of consumption is explained partly by real income dynamics. Although income growth moderated during 2012—reflecting both slower job growth and fiscal tightening that directly reduced after-tax incomes—a portion of this slowdown was offset by a corresponding decline in consumer price inflation. Consumer resilience also reflected the willingness of households to support spending growth with lower saving rates. This pattern of behavior is consistent with what occurred earlier in the expansion. Household savings rates in the G-3 have been on a modest downward trajectory for most of the past two years. In addition, households have smoothed short-term swings in purchasing power (generated by swings in inflation) via adjustments in saving rates.
A gradual acceleration is under way
In the event, the worst fears were not realized and global growth established a low-level bottom from the second quarter of 2012 to fourth quarter 2012. Viewed sectorally, this stabilization reflected the countervailing demand impulses emanating from consumers and businesses. Viewed regionally, advances in the economies of non-Japan Asia, the U.S., and Latin America offset contractions in Europe and Japan. As a result, firms have seen profits continue to grow and inventory positions gradually become leaner. Combined with the fading of concerns about China and the euro area, these developments are generating a sigh of relief from firms. The acceleration in business spending flowing from this sigh of relief, combined with continued solid gains in consumption, is beginning to boost global growth.
Hard activity data are registering the improvement. Consumer spending on retail sales appears to have ended 2012 on a strong note, with a 4 percent annualized gain predicted for the three months through December. Household purchasing power received a strong boost when sequential inflation tumbled on the back of declining energy prices and stabilizing agriculture prices. This global purchasing power boost will be magnified by the pipeline of gains in global equity prices. In addition to these drivers, recent spending was boosted by the unwinding of Hurricane Sandy effects in the U.S. and recent transitory disruptions to spending in Japan and Brazil.
The upswing in household spending growth was accompanied by a firming in business spending. G-3 capital goods orders, which tumbled 11 percent from April through September, abruptly rebounded in October/November, recovering about one-third of the previous drop. This was followed by a turn in G-3 shipments in November. In the U.S., equipment spending is on track for a strong gain in the fourth quarter of 2012, more than reversing the decline from the previous quarter. The picture is less bright elsewhere, but on present trends, the orders and shipments data point to a resumption of growth in global equipment spending in the first quarter of 2013. This demand shift, combined with extreme weakness in global IP in September and October(magnified by one-time factors including Hurricane Sandy),helped firms to make progress on inventory adjustments.
Much of the shortfall in global growth last year came from a sharp slowing in business activity, reflecting the combination of tighter EM credit conditions and broader concerns about the outlook.
The message of lift is registering even more clearly in our high-frequency barometers of global growth. Our global all-industry PMI index bottomed around midyear and moved sharply higher into year-end. The recovery in the manufacturing PMI is especially significant. The PMI’s leading indicators are signaling that global inventory adjustments are nearly completed—the level of the PMI’s index of finished goods inventory has fallen sharply to a low level, while the index of orders gradually has recovered. This combination normally is a reliable indicator that the pace of manufacturing output grow this picking up (see figure 3). The message of the surveys is strengthened by the simultaneous lift in EM Asian IP and exports. A similar message comes from our global GDP nowcaster. This tool filters information from both the business surveys and our various global activity indicators to produce a more informed estimate of real-time GDP growth. The nowcaster estimate of December growth is on track to rise to above 2.5 percent, more than a percentage point above its average reading during the previous three months.
Better is not good
History teaches that accelerations following extended periods of poor global performance tend to be surprisingly robust. Drawing on recent history, the growth lulls registered in 2002–03, 1997–98, and 1992–93 were followed by impressive rebounds in global growth. Despite this track record, we look for only a modest pickup in first-half growth, with global GDP gains averaging 2.5 percent annualized, about 0.5 percentage point better than the second half of 2012. Even with expectations that growth momentum improves as the year goes on, our forecast maintains overall growth for 2013 at 2.9 percent (4Q/4Q). Following two years of subpar growth, the global economy is expected to settle at around trend in 2013.
There are two main factors limiting lift in the global economy:
- DM FISCAL POLICY REMAINS TIGHT. The biggest obstacle to more robust near-term global growth is the U.S., where the pace of fiscal tightening is set to intensify temporarily this quarter, delivering a near-term setback to growth. Although the tightening is front-loaded, there will be some degree of drag throughout the year. The pace of fiscal tightening also will remain strong in the euro area and the U.K., although in the case of the euro area, somewhat less intense than in 2012.
- CREDIT CONDITIONS SLOW TO TURN IN EUROPE AND THE EM. Although the euro area is forecast to exit recession during the first half of 2013, growth will remain subpar in the face of continued fiscal tightening and banking system stress. In the emerging markets, access to credit also is likely to remain somewhat restrictive. The combination of swollen balance sheets and rising nonperforming loans is likely to keep banks cautious. The latest Institute of International Finance survey of EM bank loan officers illustrates these points. EM banks continued to modestly tighten lending standards, even as their access to international funding has stabilized. An extreme example where swollen balance sheets and rising NPLs are constraining credit is Brazil, where aggressive central bank easing and exhortations to banks to increase lending have had limited effect. Aside from Brazil, most EM central banks would resist a return to rapid grow thin the economy and credit. Indeed, this was a factor in the limited amount of policy easing in 2012.