Global growth strong but probably peaking
The Federal Reserve hiked rates again while announcing plans to reverse quantitative easing (QE), despite its preferred core inflation measure falling to 1.4%. The Fed is focused on an increasingly tight labour market – unemployment and underemployment1 rates are at 10+ year lows.
Economic news remained mostly upbeat despite a reduction in policy support. Confidence among entrepreneurs and bankers is the strongest since 2013-14, according to central bank surveys. House prices have slowed but housing sales and starts have continued to grow.
Labour market tightening continued but has yet to feed through to increased wage pressure. Worker shortages are the most widespread since 1992, according to the Tankan business survey. Cash earnings growth of 0.5% is barely higher than inflation.
Confidence was boosted by the election of Europhile reformist Emmanuel Macron as French President, with the EU Commission’s composite Eurozone economic sentiment indicator reaching a 10-year high. The unemployment rate fell further to 9.3%, an eight-year low.
Inflation rose to 2.9%, above the Monetary Policy Committee’s forecast, contributing to three out of eight members voting to hike rates. The economy slowed in early 2017 but the unemployment rate fell further to 4.6%, the lowest since 1975.
Inflation in the “E7”2 emerging economies has fallen significantly over the past year, in contrast to a rise in the G73 developed economies. The E7 decline reflects large drops in Brazil, India and Russia due to economic weakness and currency strength.
Trends to watch:
Narrow money4 leads the economy and has picked up since early 2017, suggesting stronger growth during the second half. Bank lending is also reviving after weakness. A continuation of these trends could signal a need for faster Fed tightening4.
Market interest rates rose significantly during the first half but inflation and currency pressures have eased, giving the authorities scope to reverse policy tightening. Producer prices have stabilised since the spring, while foreign exchange reserves have recovered.
Falling global bond yields allowed the Bank of Japan (BoJ) to slow QE while maintaining domestic yields near zero. A rebound in global yields could force it to step up purchases, attracting domestic criticism – unless the yield cap is lifted.
Unemployment is on course to reach estimates of the “equilibrium” rate in 2018, arguing that the European Central Bank should be withdrawing policy stimulus. Core inflation remains low but has firmed – a further rise could trigger a faster QE exit.
The Chancellor is under pressure to abandon “austerity” and allow faster public sector pay growth. The fiscal deficit was already forecast to rise this year and a relaxation of discipline would strengthen the case for a rise in Bank rate.
E7 real (i.e. inflation-adjusted) narrow money growth – adjusted for the negative impact of India’s “demonetisation”5 – was above the G7 level between late 2015 and early 2017. A recent closing of the gap could signal less favourable relative economic prospects.
Source: Janus Henderson Investors at 30 June 2017. These comments are the views of Simon Ward, Chief Economist, and should not be construed as investment advice. These views may differ from those of other Janus Henderson fund managers.
1 Underemployment includes part-timers wanting to work more hours and people wanting a job but not actively looking for one.
2 E7: Canada, France, Germany, Italy, Japan, UK, US. The European Union is also represented.
3 G7: China, India, Brazil, Mexico, Russia, Indonesia, Turkey.
4 Narrow money = currency in circulation plus demand depsoits and close substitutes.
5 'Demonetisation' involved the cancellation and replacement of high value bank notes with the aim of curbing counterfeiting and other illegal activities.