Weekly Economic Briefing

Stronger but riskier

17 January 2017

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What a difference a year makes. Last January financial markets were displaying signs of stress following the Fed’s decision to lift its policy rate off the zero lower bound. Now, financial markets are having few problems absorbing the Fed’s second interest rate increase. What explains the different mood music? The dominant factor is the state of the global economy. This time last year global activity was slowing, whereas it is currently picking up and translating into stronger corporate earnings growth too. The breadth of the improvement is also impressing investors; among the 20 large economies we follow, 14 had a higher manufacturing PMI last month than in December 2015 (see Table 1). Fears of deflation have also faded along with the recovery in commodity prices and headline inflation. Meanwhile, other than the attack on the Mexican peso, market participants have so far shrugged off the potential for the trade policies of the incoming Trump administration to weigh on global growth, instead choosing to focus on the benefits of possible corporate tax reform and broader US fiscal easing. Similarly, there seem to be fewer concerns about the sustainability of Chinese growth in the wake of the authorities’ decision to double down on credit and investment-led growth last year.

But investors need to be wary of complacency. Despite the perception that advanced economies lead the global manufacturing cycle, emerging markets have led the most recent cycle, thanks partly to China’s stimulus efforts. Indeed, the most comprehensive measures of Chinese lending increased by close to 20% in 2016, not that far off the heady days after the global financial crisis. At least some pull-back in credit and economic growth is likely this year and seemingly not priced into markets. The same goes for Trump’s ‘America First’ growth strategy, where the negative implications for global productivity and corporate margins are probably being underestimated. This puts us in an unusual position. On the one hand, the recent run of strong data suggests that there are upside risks to our global growth forecasts for 2017. On the other, left-hand tail risks are also clearly higher. Trump’s first 100 days in office, together with the early year Chinese credit figures, will tell us more about which force will win out.

A broad-based improvement
 
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