Insights Q3 Outlook: More of the same
The second quarter of 2013 was marked by dismal global economic growth driven by the world’s two largest economies: the US and China. The period also saw the Bank of Japan (BoJ) initiate its long-awaited quantitative easing (QE) programme. Indeed, the only surprise about the second quarter was how little attention was paid to the Eurozone – even considering the Cyprus debacle in March and the rate cut in May. Instead, the BoJ’s QE programme, concerns about QE tapering by the US Federal Reserve and the lack of action from the People’s Bank of China in the face of slowing economic activity drove headlines. And while we expect the quarter to mark the low point this year in terms of growth, the improvement in the third quarter will be minor, leaving ample room for central banks and politicians to set the agenda. Economic growth this year, at 2 percent, will be more or less on par with last year’s 2.1 percent before accelerating to 2.7 percent in 2014.
Fiscal drag keeps US growth trapped below trend
The strength of the US labour market, which has added 202,000 non-farm payrolls on average in each of the first six months, is rather impressive considering that sequestration was initiated earlier this year and that the drag exerted on the US economy from declining public spending is continuing. But the US is not out of the fiscal-drag woods yet for a couple of reasons. First, defence spending, which is down 12.6 percent since the Q3 2010 peak and down 3.1 percent in H1 this year alone. This will continue to decline in the second half of the year. And second, the projection for public spending by the Congressional Budget Office for the full year supports the notion of further cuts, including those due to sequestration. Therefore, we expect the fiscal drag to remain sizeable in the second half of the year and keep growth lower than developments in the private sector suggest.
But the fiscal drag is not all negative. The public deficit has narrowed to 4.2 percent of GDP in the first quarter from a peak of 10.1 percent in Q4 2009. Even under relatively conservative assumptions about nominal GDP and the federal budget deficit, should end the year at less than 3.5 percent. Given our expectations about further cuts to federal spending in the coming quarters, this deficit-to-GDP projection looks probable.
Our overall case for the US this year is a story of more of the same. Given modest growth in GDP in H1, we have lowered our GDP forecast for this year to 1.6 percent, slightly below the 1.8 percent consensus forecast and well below the 2.8 percent recorded in 2012. We still expect a return to stronger growth next year, when the fiscal drag will fade. The housing recovery still has legs and will continue to contribute directly through residential investment and indirectly through higher home prices, which will lift people out of negative equity and increase purchasing power.
Eurozone supertanker turning slowly but surely
The Eurozone has been in recession for the better part of two years and output is down 1.5 percent through Q1. There are tentative signs, however, that the recession is coming to an end when looking at it from quarter to quarter. Survey data, whether it is PMI or ESI, are painting a much less dark picture of the immediate outlook compared with just a quarter ago. Indeed, in July the PMI Composite crawled above the 50 threshold, which separates expansion and contraction, for the first time since January 2012. Furthermore, the drag from austerity measures, which have regrettably mostly centred on tax hikes, should fade somewhat and lessen the pressure on the purchasing power of households. That said, the turnaround will be slow due to the abundance of excess capacity in the economy – both in terms of machinery and not least the more than 19 million unemployed. Wage growth will, therefore, be muted and will keep a lid on consumption growth. Hence, we only expect a modest recovery in 2014.
In terms of yearly GDP growth rates, the story is bleaker as this year’s growth has a poor starting point due to the large drop in Q4 2012 of 0.6 percent quarter-on-quarter. We believe the Eurozone economy is on track to post even larger negative growth of 0.8 percent compared with the decline of 0.5 percent in 2012.
China’s struggle to maintain its growth rate
The Chinese economy has decelerated in 2013 as global trade growth lost momentum and the government was less forthcoming with stimuli than expected. Indeed, neither the new Chinese leadership under Premier Li Keqiang nor the People’s Bank of China have done much to arrest the weakness. Economic growth has slowed to 1.6 percent quarter-on-quarter in Q1 and 1.7 percent in Q2, both of which are below the average of 2011 and 2012. In the second quarter, the year-on-year growth rate even fell to the leadership’s target of 7.5 percent from 7.7 percent in the first quarter.
The outlook for the second half is only a bit brighter and the reasons are both structural and cyclical. Net exports and investment have driven a large part of China’s growth in recent years, but global trade is currently muted. Given the weakness of European and US consumers – relatively speaking – not much bodes for a sharp pickup in foreign goods this side of New Year. Furthermore, the level of investment in China is unsustainably high and must come down substantially in the coming decade if the world’s second-largest economy is to experience a successful transition into a developed economy. This transformation will take time and will certainly not be without bumps. In addition, the post-global recession growth in China has relied on leverage to a great extent. The debt-to-GDP ratio has increased by 56 percentage points in the five years to 2012 and now stands at close to 210 percent. All of this suggests to us that China will see its growth rate decline steadily over the next 10 years to about 5 percent.
In the nearer term, however, growth should be higher and a small uptick in the second half is on the cards. Not least if the biggest importer of Chinese goods, the euro area, performs better than the growth rate of -0.1 percent quarter-on-quarter we have currently pencilled in for Q3 and Q4. Furthermore, even if the new Chinese leadership has not engaged in any large-scale stimulus, smaller steps will be taken. Programmes similar to those for less-developed urban areas, which were announced in late June, can be expected, including, for example, transport upgrades of railroads. This is a subtler way of stimulating the economy, but is nevertheless driven by exactly that desire. Given these smaller initiatives and the fact that the government is clearly concerned about slowing economic growth, it leaves an expectation that growth will remain quite high in 2013 and 2014, at 7.3 percent and 7.8 percent respectively. However, it will, nevertheless, be far below the levels seen in (late) 2009 to 2011.