Friday, January 13, 2017 9.38 AM / ARM Research
Review of Global Economy and Markets
Over the next few weeks, we will feature excerpts from our core strategy document – The Nigeria Strategy Report. The report communicates our understanding of key happenings in global and domestic financial markets in 2016 and provides insight on what we believe will be the major themes underpinning investor sentiment over 2017. We begin the series with a look at the major themes that dominated the global economic and financial landscape in 2016 as well as our outlook on same for 2017.
Global growth remained soft over 2016 as recovery across advanced economies remained broadly anaemic while weakness in resource-rich countries bogged down growth in emerging market economies. Accordingly, the IMF estimates that global GDP likely expanded at its slowest pace since the 2009 financial crisis at 3.1% YoY in 2016. Central to the IMF’s deadbeat growth picture in 2016 is the cutback in European growth following the unanticipated Brexit vote in the UK which offset impact of improvement in US and Japan. Elsewhere, whilst commodity prices staged a recovery over 2016, many resource rich EM countries grappled with lingering impact of external imbalances and tightening global financial market conditions as US interest rates rose following Trump’s victory. Furthermore, extended growth deceleration in China, as policymakers push through with structural rebalancing, and geo-political tensions in the Middle East with a failed putsch in Turkey and unrest in Syria, weighed on EM output.
Going into 2017, recent rebound in commodity prices which should drive modest recovery across EMs as well as upbeat growth picture in the US and Japan should underpin the first expansion in global growth in three years (IMF 2017 growth forecast: +30bps to 3.4%). The positive outlook on US growth stems from expected recovery in business investment, which should receive a boost from rising commodity prices, potential relaxation of regulation burdens on oil and gas exploratory activities, and likely lower corporate and personal taxes. However, increased downside risks from political elections across the Euro Area and higher prospects of a ‘hard Brexit’ as well as anti-trade rhetoric in the face of a strong US dollar under a Trump presidency could dampen the positive momentum.
Brexit worries and EM struggles dampen global growth in 2016
In line with the pattern in recent years, global growth over 2016 was soft as the recovery across advanced economies remained broadly anaemic while weakness in resource-rich countries bogged down growth in emerging market economies. Accordingly, the IMF estimates that global GDP likely expanded at its slowest pace since the 2009 financial crisis at 3.1% YoY in 2016. Central to the IMF’s deadbeat growth picture in 2016 is the cutback in European growth following the unanticipated Brexit vote in the UK which offset impact of improvement in the US and Japan. Elsewhere, whilst commodity prices staged a recovery over 2016, many resource rich EM countries grappled with lingering impact of external imbalances and tightening global financial market conditions as US interest rates rose following Trump’s victory.
Furthermore, extended growth deceleration in China, as policymakers push through with structural rebalancing, and geo-political tensions in the Middle East with a failed putsch in Turkey and unrest in Syria, the IMF lowered its 2016 growth projection for EM countries 10bps from its January forecast to 4.2% YoY.
Despite the softer growth picture and electoral upheavals, global financial markets closed the year on a strong note (MSCI world index: +5.3%) as investors digested vote outcomes quicker than expected. In the case of the UK, markets marked down the value of the UK pound, as preliminary divorce negotiations suggested a hard ‘Brexit’ for the UK.
However, in a similar script to Brexit, negative market reaction to the Republican party’s victory at the elections was quickly followed by an upswing in US markets and in the US Dollar as investors viewed Trump’s economic plans as net positive for US growth.
Figure 1: Trends in Global GDP Growth
Focusing on Developed Economies (DM), the US economy grew at its fastest pace in two years (seasonally adjusted annualized growth: Q3 16: +3.5%, Q2 16: +1.4%) in the third quarter as a surge in exports (+8.2pps QoQ to 10%) and a rebound in inventory investment1 offset a slowdown in consumer spending (-1.3pps from prior reading to 3%). The robust export growth reflects acceleration in overseas shipments from increased US soybean exports which together with the inventory gains suggest a soft growth underbelly. On the other hand, US headline inflation inched closer to the US Fed target of 2%, with November reading printing at a two year of 1.7% YoY even as jobs data remained sturdy2. That said, the macro developments were more a side-show in 2016, as after tumbling3 in the aftermath of the unexpected victory of Donald Trump at the November presidential elections, US financial markets rallied to record highs. The upsurge in equity markets performance reflects anticipated stronger US economic growth given the US president-elect’s infrastructure investment program and lower tax reform pledges. Trump’s election victory also jolted US fixed income markets, as his stimulus rhetoric and promise to lower US corporate and personal taxes4 which imply higher debt issuance, drove US Treasury yields higher over the last two months of 2016. Though markets moved quicker than the US monetary policy makers, the Federal Reserve at its last FOMC meeting in 2016 hiked interest rates for the second time in a decade by 25bps and guided to three rate hikes over 2017. Unsurprisingly, the increased demand for US assets resulted in the strengthening of the dollar over H2 16 (+6.3%), driving the ICE dollar index to a 13-year high (2016: +3.6%).
Figure 2: Performance of US equity indices
Figure 3: Trend in US Treasury securities
Across the Atlantic, Euro Area GDP rose 0.3% QoQ in Q3 16—unchanged from prior quarter—as growth deceleration in Germany and Spain neutered improved output in France, Italy, Greece, and Portugal. Germany’s economic slowdown largely reflected impact of Brexit on exports5 (-1.6pps to -0.4% QoQ) while slower growth in both household consumption (-10bps to 0.6% QoQ) and fixed investment (-1.6pps to 0.3% QoQ) weighed on Spain’s GDP. Elsewhere, in addition to improved investment (France: +30bps to 0.3% QoQ, Italy: +1.1pps to 0.8% QoQ) which helped France rebound from its negative growth in Q2 16 (Q3 16: +0.2% QoQ), Italy’s growth benefitted from higher domestic consumption (+20bps to 0.2% QoQ).
Figure 4: GDP growth across Euro Area countries
However, other economic indicators across the Euro area fared better with unemployment falling to a seven year low of 9.8% in October 2016 while YoY inflation rose to a two and half year peak of 0.6% in November. The latter reflects a 5.6% depreciation of the euro over H2 16 (YTD: 3.2%) largely on account of the strengthening US dollar. Though the European Central Bank (ECB) made no changes to its key policy rate in 2016, it extended its bond buying program to December 2017. However, in response to the rising inflationary expectations from the depreciating euro, the ECB announced a €20 billion per month cutback in asset purchase program to €60 billion starting March 2017.
Outside the Euro Area, the UK economy struggled to shrug off worries about impact of potential exit from the European Union (EU) as growth slowed 20bps from prior reading to 0.5% QoQ in Q3 16. Uncertainty surrounding Brexit underpinned contraction in Industrial production (-0.5% QoQ), Construction (-1.1% QoQ) and Agriculture (-0.7% QoQ) which offset gains in the Services sector (+0.8% QoQ). In a bid to prevent a hard landing, the BoE cut its key interest rate (-25bps to 0.25%) for the first time in nearly seven and a half years, introduced a new Term Funding Scheme worth up to £100 billion and raised its asset purchase program by £70 billion to £445 billion. Largely reflecting the accommodative monetary stance, which had been envisaged since the Brexit Referendum, as well as Prime Minister May’s announcement of triggering article 50 by March of 2017, the sterling fell another 7.8% over H2 16, bringing 2016 GBP depreciation to 19.4%. Though effect of the weaker currency underpinned a jump in inflation to a two-year high of 1.2% YoY in November 2016, it, nonetheless provided a welcome distraction to the share prices of London-listed export-driven, internationally focused companies. This together with recovery in commodity prices (H2 16: GSCI: +6.5%), which provided a boon for oil and gas (15% of market capitalization) and industrial goods (6% of market capitalization) shares, drove the FTSE 100 9.8% higher over H2 16.
Figure 5: European equity market performance
Japan’s economy expanded 0.5% QoQ in Q3 16 (annualized rate of 2.2% in Q3 16 vs. 0.7% in Q2 16) on the back of higher government spending (+0.4% QoQ), but more importantly recovery in exports (Q3 16: +2% QoQ, Q2 16: -1.5% QoQ), which mirrored rising value in shipments of smartphone parts. In line with prior years, economic policy remained expansionary as Shinzo Abe government introduced a Y13.5 trillion stimulus for cash payouts to low-income earners and infrastructure spending in August. Not to be outdone, the Bank of Japan (BoJ) followed up its negative interest rates policy and expansion of the scope of its asset purchase program over H1 16, by announcing a 0% target for Japanese 10-year interest rates in September. Furthermore, despite limited traction on its inflation goal (November 2016: 0.5% YoY), the bank restated its commitment to sustained policy accommodation to meet its 2% target. Impact of the stimulus and USD strength swung the Yen 13.3% lower over H2 16 (2016: +2.7) which was enough to spur investors’ appetite for Japanese equity instruments with the Nikkei 225 index rising 23% over H2 16. (YTD: +0.4%).
Figure 6: Trend in Japanese Equities and Currency
Recession across commodity exporters weighs on EM growth
China’s economy expanded 6.7% YoY in Q3 16—same growth as with the prior two quarters—as higher government spending (+12.5% YoY) and improved investment (+8.2% YoY) offset slowdown in industrial production (-20bps from prior reading to 6.1%) and contraction in exports (-7.2pps from prior reading to -10%). The rise in government spending is in line with record fiscal deficit of 2.18 trillion Yuan (+35% YoY) budgeted for the year with corresponding 3% budget deficit to GDP being the highest in over three decades. Beyond Q3 16, China’s economy remained resilient as the country’s composite PMI reading rose to a 43-month high of 52.9 in October, a reading unchanged in November. Thus, appetite for China’s equities improved over the second half of the year (Shanghai composite index: +5.9%) helping pare losses from the first half of the year stemming from concerns about a hard landing for Chinese GDP.
The Chinese equity market also benefitted from the December 5th launch of the Shenzhen-Hong Kong Stock connect, a trading link which allows global investors access to 881 stocks in the tech-heavy Shenzhen market via Hong Kong bourse. In a bid to stem sustained depreciation of the Yuan (H2 16: -4.5%, YTD: - 6.9%) stemming from capital outflows and strengthening of the US dollar, China’s government increased its scrutiny of overseas investments even as Peoples Bank of China (PBoC) intensified its intervention in the FX market causing the Chinese FX reserves to fall to its lowest level in five and half years (November 2016: $3.1 trillion).
In Brazil, despite closure on the political upheaval, with confirmation of Michel Temer as president in September, Brazilian GDP contracted for the ninth consecutive quarter (-2.9% YoY in Q3 16) as consumption and investment expenditure contracted 8.4% and 3.4% respectively. Though a recovery in commodity prices underpinned meagre gains in exports (+0.2% YoY), continued fiscal retrenchment (-0.5% YoY) ensured output growth remained under chains.
Unsurprisingly, Brazilian unemployment climbed to a new peak of 11.9% in November while composite PMI remained in contraction territory for the twentyfirst month in November at 45.3. On the policy front, following continued declines in inflation which hit a 23-month trough in November at 6.99%, the Central Bank of Brazil lowered its benchmark Selic rate by 50bps over two meetings to 13.75%.
However, fiscal policy remained hawkish as President Michel Temer put forward plans to raise retirement age for workers to 65 (vs. Brazil’s mean retirement age of 54 years) and obtained parliamentary approval to freeze inflation-adjusted non-interest expenditure of the government over the next ten years. As in H1 16, the reformist stance policies of the Temer government continued to bolster sentiment in Brazil with the Markit Brazil Business outlook, a business confidence index, hitting 32-month high of 57% in October. Markets also shared the optimism with Brazilian equities extending the bull run over H1 16 with a 16.9% gain in H2 16. Nonetheless, on the currency side, after a stellar H1 16 (+18.9%), the appreciation of the US dollar drove a 1.3% depreciation in the Brazilian real in H2 16.
Russia’s economy contracted at its slowest pace in seven quarters, declining 0.6% YoY in Q3 16 (Q2 16: -1.2% YoY) as higher crude oil prices helped the country shrug off waning impact of western sanctions. Though breakdown of economic growth has not been released yet, clues from PMI data, which printed at a four-year high in November (55.8) suggest improved output from manufacturing sector, which returned to growth after six quarters of declines in Q2 16 (+0.3%), likely underpinned the enhanced growth picture. Specifically, manufacturing PMI readings jumped to a 68-month high of 53.6 in November, which together with sustained growth in Services (November PMI: 54.7) underpinned the highest composite reading in four years in November (55.8). In a similar vein, Russian inflation eased to a four-year low of 5.8% YoY in November even as rebounding oil prices and increased prospect of sanctions removal under a Trump presidency spurred 3.7% appreciation in the Russian Ruble in H2 16 (YTD: 15.1%). The declining inflation picture permitted further monetary policy easing as Central Bank of Russia cut its key one-week repo rate 50bps to 10% in H2 16. Feeding off the broad recovery theme, Russia’s equities have rallied 17.8% over H2 16 nudging YTD gains to 26.4%.
Figure 7: Trend in Russia’s real wage growth (YoY)
Lastly, India’s economy maintained its glowing pattern as Q3 16 GDP printed 20bps higher than prior reading at 7.3% YoY. Improved private consumption (Q3 16: +7.6% YoY, Q2 16: +6.7%) neutered slowdown in government spending (Q3 16: +15.2, Q2 16: 18.8%) and contraction in investments (-5.6%). Lower energy prices, deceleration in inflation (November: 3.63 %, target: 4%) and expansionary monetary policy (interest rate: -25bps to 6.25%) has helped India in sustaining its strong growth.
However, implementation of a demonetization policy in November appears to be slowing economic output as the country’s Services PMI (46.7) contracted for the first time in 17 months in November while manufacturing activities slowed from its 22-month high in October (54.4) to 52.3 in November. Given India’s elevated proportion of cash to total consumer transactions (90%) and the fact that withdrawn currency notes constituted 86.4% of India’s currency in circulation, the limited period for exchanging the old bills for new notes (8th of November to 15th of December) underpinned sizable cash crunch in the country which negatively weighed on the equities market (H2 16: -1.4%, 2016: +1.9%). However, Indian bond markets have been on a bullish run, as sizable deposits (5.45 trillion rupees from November 10 to 18) applied downward pressures on interest rate, with yields on India 10-year bond falling to its lowest in more than seven years to 6.2%.
Figure 8: Performance of EM Equity Indices
Improved US growth outlook and rising commodity prices buoy global growth
Going into 2017, the IMF estimates a 30bps expansion in global GDP to 3.4% YoY - first growth in three years—as recent rebound in commodity prices which should drive modest recovery across EM combines with stronger growth in the US and Japan. Across DM countries, where growth is projected 20bps higher than 2016 at 1.8% YoY, the US economy is expected to be driven by recovery in business investment as rising oil prices and potential regulation laxity on oil and gas exploratory activities boost energy investment. Furthermore, sturdy jobs data (the FOMC forecasts unemployment to fall 20bps YoY to 4.5% in 2017) and rising wage growth, which could receive a boost from Donald Trump’s expansionary fiscal policies (tax cuts and infrastructure spending) holds positive connotation for consumer spending (two-thirds of GDP).
However, reflecting potential impact of dollar appreciation on exports (13% of GDP), overall growth is forecasted to rise a modest 20bps by the FOMC to 2.1% in 2017. The improved growth picture, strong labour data and prospect for expansionary fiscal stimulus underpins FOMC guidance of further monetary tightening over 2017. In a similar vein the IMF expects Japan’s economy to rise 10bps to 0.6% YoY largely reflecting impact of sustained monetary easing (the BoJ promised accommodative monetary policy pending when inflation hits a 2% YoY target), Yen depreciation on exports as well as the aforementioned fiscal stimulus announced in October which should help boost domestic consumption. The government has also scheduled a wage negotiation meeting between companies and labour unions in 2017 with a likely agreement to raise wages expected to boost output and inflation.
In Europe, the market focus in 2017 should revolve around the UK’s divorce from the EU starting in January when the UK Supreme Court delivers judgement on whether Prime Minister Theresa May can trigger Article 50 without a vote in parliament. Depending on the outcome, rhetoric among EU leaders remain hawkish towards the UK with increased prospect of a ‘hard Brexit’. As in Q3 16, the uncertainty over the final divorce terms should continue to weigh on UK economic activities with the IMF estimating a 70bps cutback in growth to 1.1% in 2017. On the continent, the feed-through from slowdown in domestic consumption in the UK should have a reverberating effect on EU exports (42.4% of UK’s imports come from the Euro-Area). Beyond the macroeconomic imbalance from Brexit, increased voter discontent with mainstream EU parties and the rise of nationalist parties imply political risk given the slew of elections in key EU countries should be another factor militating against growth in 2017.
Table 1: 2017 elections in Europe
Furthermore, EU’s recent suspension of a €45 billion bailout program to Greece as well as possible delay in approval of the second bailout program scheduled for January 2017 could mar the country’s economic recovery over the coming year. That said, continued monetary policy accommodation and impact of a weaker euro provides upside to IMF growth forecasts for the region in 2017, though admittedly, heightening political risks imply greater volatility around growth.
For emerging markets, IMF forecasts growth to rise 40bps to 4.6% in 2017 largely reflecting economic recovery in Russia and Brazil. Russia’s economy is expected to benefit from recovery in oil prices which in addition to boosting investment raises prospect for higher government expenditure ahead of elections in 2018. Supported by an improving inflation picture which gives room for more rate cuts, IMF projects that Russia should exit recession in 2017 (+1.1% YoY vs 2016E: -0.8%YoY).
In Brazil, waning political uncertainty, rising business confidence and higher commodity prices, all of which bodes well for investment, is expected to drive mild economic recovery in the country (IMF: 2017F: +0.5%, 2016: -3.3%). For India, downside from the persisting cash shortages following the demonetization program should create a drag on consumption spending. Lastly, in addition to ongoing economic restructuring from investment-led to consumption-led economy which should continue to apply downward pressure to growth, China’s exports could be impacted by Donald Trump’s trade policies which includes possible imposition of tariffs on Chinese goods.
Overall, the picture for global growth in 2017 appears finely balanced across the various regions. That said, increased downside risks from political elections across the Euro Area and anti-trade rhetoric in the face of a strong US dollar under a Trump presidency could dampen the positive momentum.
Figure 9: 2017 Global growth projection
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