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The danger of jumping the recovery gun

The degree of confidence many are now showing in the global economy is cause for some concern. Sure, global growth has picked up in the last couple of years – but where is the broader strengthening occurring?  

We forecast global growth at 3.7 per cent in 2017 and 3.8 per cent in 2018 – in the wake of a 3.2 per cent rise in 2016. As such, much of the global growth pick-up has already occurred.

In fact only in Australia is growth in 2018 expected to be materially stronger than 2017; and even then much reflects base effects from a weak first quarter in 2017.

"Much of the global growth pick-up has already occurred.” - Richard Yetsenga

Growth in China is likely to continue to moderate over time, not least because of the lagged effects of tighter monetary policy, and Asia has seen the best of the export upswing. 

While this makes us less ebullient than some, it shouldn’t distract from the observation that growth is somewhat above trend in many economies.

It has been sufficient to generate the beginnings of a groundswell amongst central banks that the point of most easing conviction has passed. The European Central Bank, Bank of England, and Reserve Bank of Australia are all at least talking about a cycle where conditions are improving, rather than the opposite.

How far the US Federal Reserve can keep tightening - and whether other central banks can start - will depend crucially on developments in wages and inflation.

We expect modest rises in inflation in a range of countries, including the US, Japan and Australia, but not by enough to make it obvious there is a linear trend to tighter monetary policy globally.

Certainly moving away from the point of maximum policy accommodation is likely to prove an inexorable trend. It is expected, however, to be gradual, episodic and uneven.

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Concerns

Wages in virtually all economies continue to run well below where standard indicators suggest they should be and underlying inflation as a consequence remains below target for virtually all targeting central banks.

Like many, we struggle to fully explain why this dynamic seems to be so entrenched. Certainly technological change, retail sector adjustment, worker insecurity and a possible shift towards a winner-take-most economy would all seem to have roles to play. 

Of course if we are trying to explain cyclical developments using structural explanations then by definition the timing of any reversions will be difficult to forecast ahead of time.

THINGS TO WATCH

•The hard data will need to pick up further to support the consensus of further acceleration.

• Wage growth remains frustratingly low, and will need to broaden to validate reflationary expectations.

• The move away from maximum easing is likely to be elongated and episodic.

• China’s slowdown needs to remain contained to validate global recovery expectations.

As a consequence there seems to be little choice but to apply a more probabilistic framework around the likely path of global monetary policy. This also implies us being somewhat reactive in our views.

We expect over the second half of 2017 this divergence will likely be resolved to a substantial degree. Either it will become clear there has been a durable reduction in inflation-proneness post crisis, or cyclical relationships as we understand them will start to make their presence felt.

Gradual

The central view underlying our forecasts suggests most central banks in advanced economies will continue to gradually move away from extreme monetary accommodation, although we don’t expect the European Central Bank to shift rates until very late 2018. New Zealand is also in this group.

In contrast, the modest nature of the recovery will actually leave room for some central banks, particularly India, to countenance easier monetary policy.

There is also some risk Australia may slip into this group if wages don’t start to recover. Forming a consequent view on the asset market and economic impact of the unwinding of QE is not trivial.

Certainly there is a vanilla presumption as the introduction of quantitative easing encouraged yield curves to bull flatten, capital to find a home in alternative assets and drove volatility down, it’s unwind should reverse these effects.

The vanilla approach, however, presumes the world of the QE unwind is the same as the world of QE introduction. Patently that is not the case.

The reality is the world as it currently stands simply cannot handle interest rates at levels we think of as more ‘normal’. Part of this is about debt levels.

Most important are rates of income growth. The combination of these two forces implies interest rates simply cannot increase very much, or asset markets decline too substantially, without a cost to growth.

Until the income story, at the very least, starts to change, it’s hard to see bond yields increasing sharply. 

Our commodity views in many ways reflect the modestly above-trend nature of global growth. Growth is neither strong enough nor weak enough to drive a large and synchronous commodity cycle.

Neither is the $US a large influence, as was the case in 2014. As a result, other influences, like supply, are left to exert their idiosyncratic effects unevenly across the commodity spectrum.

For currency markets, the evolution towards the end of unconventional monetary policies is likely to be the defining feature of exchange rates.

We expect a gradual decline in official sector liquidity to bring overall liquidity down. This should bifurcate currencies along risk lines – with the Yen and Euro outperforming risk-sensitive currencies in Asia, $A and $NZ. Do not expect, therefore, a uniform strong $US trend to emerge in currency markets.

Headwinds

The increased confidence in growth also shouldn’t completely distract from the structural headwinds which persist.

Even in the US, which is furthest advanced in its economic cycle, there has still been no meaningful improvement in the level of public debt, business investment remains subpar and broad money supply growth remains well below what was common pre-crisis.

There is sufficient evidence to suggest, therefore, well beyond wages and inflation, all is still not ‘normal’ in the world.

One structural concern from many is the impact of demographics and more aged populations. We are less concerned than most on this issue, despite the policy challenges inherent herein.

Already people are working longer as working life reconverges with life expectancy, technology is sustaining participation, and small open economies are responding through their migration policies.

The impact of more prudent banking sector activity on growth, however, is likely to be a more sustained issue.

A decade after the crisis many economies are still tweaking their strengthened financial stability regimes to make them even more robust. Both the UK and Australia have made recent shifts in this regard, even if the US is on the cusp of tilting the other way.

The stability wins from this are undeniable. The growth impacts are less obviously recognised but are likely to be substantial.

Richard Yetsenga is Chief Economist at ANZ

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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