PineBridge Investments has released its annual Investment Outlook Mid-Year Update – “The Global Economy Slowly Inches Upward," which finds that the global economy remains on a recovery trend, but the path continues to be more uneven than expected at the beginning of 2015.
The PineBridge 2015 Mid-Year Update looks at how the global economy has performed as compared to predictions at the beginning of the year. Growth in the US and China has slowed, with the latter likely to undershoot the politically sensitive 7 per cent growth target. Eurozone equities and bonds have been a pleasant surprise this year, and PineBridge notes that Russian markets have rebounded despite sanctions and the conflict in Ukraine, while in Brazil, the re-elected government has missed an opportunity to enact reforms.
Markus Schomer, Chief Economist at PineBridge Investments and author of the Mid-Year Update, says: "We believed this would be a pivotal year for the global economy and global financial markets. 2015 still has that feel, but it is unclear in which direction we are pivoting."
"The global business cycle remains unsynchronised. Different economies have reached different stages in the recovery. The lack of debt deleveraging is one of the few traits most economies have in common," Schomer says.
United StatesAfter six years of unconventional monetary policy, the US Federal Reserve is likely to finally start removing the extraordinary policy accommodations and move interest rates back to a more neutral setting. The main driver for such a policy change is neither booming growth nor runaway inflation, but the gradual normalisation of economic fundamentals.
"Weaning the economy off unlimited money printing and quasi-zero interest rates is proving harder than we and the Federal Reserve policy makers had expected," Schomer states. "We still expect the Fed to raise rates in September. Yet even we have taken down our policy rate targets to 0.75 per cent for the end of this year and 1.50 per cent at the end of 2016. Driving the downgraded outlook are question marks surrounding the strength of the US recovery."
PineBridge predicts a more subdued 2.6 per cent growth rate this year, down from its previous prediction of 3.1 per cent, due to sustained weakness in US business investment and the fact that consumption slowed during a period of rapidly falling energy prices. PineBridge sees 10-year Treasury yields remaining around 2 per cent over the summer, increasing only marginally to 2.25 per cent towards the end of the year with the first Fed rate hike.
EuropeEurope is proving to be the growth surprise that PineBridge predicted in the previous Investment Outlook. While the US economy slowed abruptly over the winter, the Eurozone produced its fastest growth rate in four years.
"The effect of ECB QE on markets is beyond doubt. As our Multi-Asset team correctly predicted, Eurozone risk assets, especially equities, surged much in the same way as US equities rallied during the Fed's QE programs," Schomer says. "Europe has been the best performing major equity region so far this year, outpacing the US by a wide margin."
As a result of the broadening growth trend, PineBridge has raised its growth forecast for the Eurozone to 1.4 per cent from the more moderate 1.1 per cent predicted at the beginning of the year. The only exception to the improving European outlook is Greece. The current standoff has damaged Greece's relationships with the very institutions it relies on to avoid bankruptcy and has pushed the country back into recession.
RussiaThe conflict between Russia and Ukraine has dominated Eastern Europe since the annexation of Crimea more than a year ago. While the Minsk II Protocol between Ukraine and Russia has significantly reduced the level of violence in the region, a swift removal of sanctions against Russia seems unlikely. The IMF dramatically reduced its forecast for Russian GDP growth in April and now forecasts a deep recession this year and no rebound until 2017.
Schomer says: "Never mind the bearish economic outlook, though. Stocks have rallied in 2015, more than reversing last year's losses. Russian equities and corporate bonds have been among the best investments so far this year, helped by a resurgent ruble."
Latin AmericaApart from Russia, Brazil suffered the most serious growth downgrade in the IMF's bi-annual World Economic Outlook, with surveys showing Brazil's economy is slipping deeper into recession. Meanwhile, despite increasing uncertainty about economic and social reforms, growth in Chile rebounded more than expected in the first quarter. Mexico started the year on a weaker note due to its close correlation with US growth trends, but should rebound in line with PineBridge's forecasts for the US. Peru and Colombia should continue to benefit from smart infrastructure investment.
Schomer says: "Brazil was always going to be critical in turning structural reform efforts in a disparate group of countries into a broader emerging market investment theme. We hoped Brazil's re-elected government would interpret the election result as a sign that voters trusted it more with instituting reforms. Instead, Brazil is turning into the biggest disappointment."
ChinaIn China, reforms were also on the agenda as a tool to facilitate the pivot away from investment-led growth to a more consumption-based model. Recent data does not suggest that the strategy is working. Chinese GDP growth slowed more than expected in the first quarter, prompting the government to revert to more aggressive monetary policy easing to lean against the accelerating slowdown.
The Mid-Year update notes that: “China's politically sensitive 7 per cent growth target already seems to have slipped out of reach. Furthermore, using more accommodative monetary policy when households and companies are already over-leveraged may increase the risk of a deeper financial crisis down the road, while delivering little in terms of additional economic growth."
JapanJapan was the first economy to experiment with QE and it seems to be the first to experience its limits. The Bank of Japan doubled its monthly asset purchases in early 2013 and raised its inflation target to 2 per cent. Growth and inflation did trend up initially. Yet last year's consumption tax hike exposed the fragility of a predominantly monetary policy-driven recovery as Japan fell back into its third recession since 2009.
"Two years into its accelerated QE program, Japan is back where it started: close to recession and deflation. As a result, we have reduced our growth forecast for Japan to 0.6 per cent for this year, down from the 1.1 per cent call in the original investment outlook," the report states.
IndiaEmerging market reforms are proving tough work, although India is setting a surprisingly good example. India continues to embrace reforms to make it easier to do business, which will gradually lift the country's growth potential.
Schomer believes that: "The economy is showing the fruits of the sound economic policies introduced by the dream team of Prime Minster Modi and central bank Governor Rajan."
Middle EastFollowing last year's dramatic decline in oil prices, which was driven initially by OPEC's decision not to cut production, oil producers in the Middle East have not changed their strategy, despite the negative impact it has had on government revenues and, possibly, on future investment.
Schomer predicts: "Regional growth will likely run below the expectations expressed in our original investment outlook. However, the underlying investment thesis remains quite bullish."
AfricaGrowth prospects in Sub-Saharan Africa have suffered from the sharp decline in commodity prices. However, PineBridge believes that the bigger problem for the region is the fragmentation of the global recovery and the weak growth in global trade.
The report states: "In recent years, Sub-Saharan Africa has benefited from deepening globalisation and inclusion in increasingly global manufacturing chains. Further progress in reducing trade barriers around the world through the free-trade agreements being discussed by the US, Asia and Europe would also benefit Sub-Saharan Africa through the broader stimulus to global trade."
