The global economy will continue its dual-speed recovery in 2011, with developing and developed economies occupying “parallel and very different financial universes,” Invesco’s chief economist, John Greenwood, writes in his economic outlook for 2011.
While continued balance-sheet repair in the more over-indebted economies such as the US, the UK, Spain and Ireland will cap growth and inflation in the West, Greenwood projects a continued healthy recovery in the emerging world.
According to Greenwood, the new crises that have erupted in 2010 – e.g. Greece and Ireland in the eurozone – are actually part of the process of exposing and recognising in accounting terms the true extent of the problems built up during the preceding bubble.
“The next step is to identify the range of entities among which the burden of losses must ultimately be shared – principally private shareholders, creditors and taxpayers,” Greenwood says. “In some cases the weight of outstanding obligations will ultimately require a restructuring of interest and debt repayment schedules, with corresponding losses for creditors. These processes will continue into 2011 and beyond.”
Marked by the experience of debt, banking and currency crises in the 1990s, the Asian and Latin American economies, in turn, preserved their healthy balance sheets during the past decade of bubble and burst in the western developed nations. As a result, recoveries in the emerging world have been far more vigorous than in the developed economies and have led to accelerated money and credit growth, rising asset prices and inflationary commodity price increases.
In a continually buoyant economic environment, Greenwood expects the emerging economies to spend much of 2011 addressing the consequences of these pressures – through currency appreciation, currency sterilisation or capital controls.
“In financial markets, the divergence between economic conditions in the developed and emerging universes will complicate the asset allocation process,” Greenwood says.
In the developed markets, where currently persistently low interest rates on deposits are likely to drive a continuing search for yield, investors may consider yield products such as corporate and high-yield bonds or “bond-like” equities that are perceived to be safe but offer a high dividend yield.
“In the emerging world, rising rates and inflation reduce the attractions of yield products, while on the equity side domestic demand stories could continue to benefit from strong economic growth, even though valuations may be high,” Greenwood says.
Two alternative investment options could be explored: to buy emerging sovereign debt denominated in US dollars and to hold equities in developed economies which have high exposure to the emerging world.
On a regional level, Greenwood expects the US economy to run well below capacity through 2011 and 2012 as households and financial institutions continue to repair their balance sheets. If households and companies continue to repay bank debt and banks remain risk averse, the Fed’s second round of quantitative easing could fail to have any effect on bank lending in 2011, Greenwood notes: “exactly the problem that the Bank of Japan encountered when it pursued QE between 2001 and 2006.”
Greenwood projects real GDP growth of around 2.4 per cent and CPI inflation of 0.8 per cent for the US in 2011.
Like the global economy, he expects the eurozone economy to remain split in two in 2011, with the northern part – France, Germany and the Benelux – experiencing a healthy recovery and the southern and western periphery continuing to struggle with the rolling sovereign debt-cum-banking crisis. Although the smaller crisis economies may see a further decline in economic activity in 2011, Greenwood does not expect this to drag down the more buoyant core economies.
“Undoubtedly there is still a risk of contagion for Portugal, Spain and possibly Belgium or even Italy where debt levels are high or banking problems persist, but while the rescue mechanisms may need to be scaled up in 2011, the procedures are now largely in place.”
Overall, Greenwood projects 1.6 per cent real GDP growth for the eurozone in 2011, with low money and credit growth coupled with considerable slack in employment and capital equipment capping inflation in 2011 and 2012.
While the UK is finally showing signs of a self-sustained recovery, the government’s austerity measures and weak real income growth will likely create economic headwinds in 2011.
“The recovery should gain a bit more momentum in 2012 as the export recovery gains traction and business investment starts to grow more robustly,” Greenwood says.
Overall, he projects real GDP growth of 2.3 per cent for the UK in 2011.
On the back of reviving private domestic demand and strong corporate profitability, Greenwood projects real GDP growth of 1.6 per cent for Japan in 2011. However, he expects deflation to continue and believes that Japan’s shrinking labour force and ageing population will act as a drag on real GDP growth over the long term.
Meanwhile, the recovery in the emerging world – with the sole exception of perhaps the Eastern European economies – is expected to continue at a healthy pace in 2011. Although some emerging economies, such as China and India, have begun to raise rates and implement other policies to restrain demand and inflation, Greenwood does not expect these policies of restraint to be so severe as to terminate the business cycle expansion. Greenwood forecasts real GDP growth of 9.3 per cent and 8.3 per cent for China and India, respectively, in 2011.
