The U.K. will be living the consequences of Brexit for years to come. Yet the rest of the world seems to have moved on. That is the conclusion you would draw when observing the past few months’ movements in global stock markets. But there is no getting away from the fact that the global recovery is still heavily dependent on growth in the U.S. — and the extreme efforts of central banks.
There was a fear, in the days after voters chose to take the country out of the European Union, that the U.K.’s troubles would sink the global recovery. Whatever the political risks, investors quickly decided that for stocks and bonds this shock was actually a win-win. Why? Because growth would not be much affected outside the U.K., but central banks were likely to keep policy looser than it would otherwise have been, just to be safe. That explains why many stock markets reached new highs during the summer — even in the U.K.
A year ago the obsession was China. You’ll remember that stock markets fell around the world when the Chinese authorities announced a surprise depreciation of the yuan against the U.S. dollar. The fear was that a deflating Chinese economy would export its falling prices to the rest of the world, via a lower exchange rate, and take another bite out of growth in emerging markets.
Funnily enough, the Chinese currency has been falling again recently — by slightly more than it did in the summer of 2015. That might in part be because investors believe the world is now in a stronger position to cope with a deflationary China than it was a year ago. Or, there’s another explanation: They simply haven’t been paying attention.
It is true that this recent depreciation by China feels somewhat more controlled. What spooked investors about China last summer was the feeling of chaos. The mixed messages about the currency and the panicky moves to prop up the domestic stock market both had a whiff of panic. If the authorities could not achieve a smooth transition for the exchange rate, how were they going to deliver one for the broader economy?
It feels different this time. China’s authorities now have a plan. The currency is supposedly now linked, not to the dollar but to a broader basket of currencies, as recognized by the China Foreign Exchange Trade System. If investors had been paying attention, though, they would have noticed that the authorities only follow the new system when it allows the currency to fall. When the CFETS was rising against the dollar in the first part of the year, the Chinese currency barely rose at all. The net result is that the Chinese currency is nearly 7 percent weaker on a trade-weighted basis than it was at the start of the year.
On the surface, China’s economy does look less scary than it did a year ago. Keep in mind, though, that the authorities are using the same tools to support growth that they have used in the past: public investment and subsidized credit. Fixed-asset investment by state-owned companies grew by more than 20 percent year-over-year during the second quarter of 2016.
Many observers would say that China is not any closer to resolving its structural and financial imbalances than it was a year ago. This latest depreciation also means that the country is still exporting disinflation to the rest of the world via a weaker exchange rate.
The U.S. can probably shrug off the disinflationary effect of cheaper Chinese imports because domestic prices — and, finally, wages — are now picking up as the consumer-led recovery in the U.S. continues to move ahead. Globally, however, the picture is not nearly so strong. The International Monetary Fund’s latest global forecasts show global consumer inflation at just 0.7 percent in 2016. It is striking that the U.S. and the U.K. have the only central banks in the developed world that are expected to achieve inflation at or above their targeted 2 percent by 2017.
Those IMF forecasts, revised and released during the summer, are helpful — not because they are likely to be right but because they let us step back from the day-to-day economic reports to see how global growth expectations have changed over time. At 3.1 percent, the new IMF global growth forecast for 2016 was only slightly lower than the April forecast. This modest dip was taken as more evidence that the negative effects of Brexit are likely to center on the U.K. A year ago, though, the IMF was expecting global growth this year to be 3.8 percent, and growth for the advanced economies to be 2.4 percent. The IMF’s best guess now is for growth of 1.8 percent in those countries — not just in 2016 but in 2017 as well.
The IMF’s forecast for world trade has also been slashed, yet again. We have now had six consecutive years in which world trade has been flat or falling as a share of global GDP.
Trade had been growing faster than world output, especially onward from 1980, as emerging-markets economies became more integrated with the global economy and global supply chains became more complex. That growth could not carry on forever. At the same time, though, these long-term factors cannot explain why world trade should be quite so weak, for quite so long. It’s certainly bad news for emerging-markets economies, which had previously relied heavily on exports to fuel their growth.
It would be good news for the emerging world if global — and especially U.S. — monetary policy were looser in 2016 than most had expected at the start of the year. Investors who have been flocking to buy emerging-markets assets in the past few months should be wary, however, of making a long-term bet on these economies solely in response to short-term expectations about the U.S. Federal Reserve. Brazil and Russia may now be past the worst of their recent economic stumbles. Yet they and other emerging markets are still struggling to produce strong domestic demand growth, and in most of these countries the average growth in corporate earnings has yet to pick up.
None of this suggests that the global recovery is about to grind to halt. In fact, recent data suggest that the U.S. economy is doing a little better than our fears would have led us to expect a few months ago. Also, the euro zone seems to have been less affected by the immediate shock of Brexit than many had predicted.
The first consensus estimates showed the euro zone growing at a quarterly rate of 0.3 percent in the three months ending in June. That’s slower than the surprisingly strong figure for the first three months of the year, and, of course, these numbers would not have been able to capture any Brexit-vote effect. The surveys and economic sentiment numbers that have been released recently, however, do not show any big lurch downward in response to the U.K. vote.
That relatively weak prediction for euro zone growth in the second quarter is much less than the region needs to grow out of its reliance on superloose monetary policy and to make serious inroads on unemployment. It also reminds us that the world is expecting an awful lot of the U.S. economy right now, and an awful lot of its central bank.
With the Fed’s help, the U.S. has managed a respectable recovery, despite a deeply needy global economy and an unhelpful rise in the dollar. So far the signs are that this recovery is doing just fine, despite the dysfunctional cacophony coming out the U.S. presidential campaign. We should all hope that continues to be the case, because right now the world does not have much of a Plan B.
Stephanie Flanders is chief market strategist for the U.K. and Europe at J.P. Morgan Asset Management in London.
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