With the US Federal Reserve (Fed) starting on a series of fed fund rate hikes from Dec. 16, 2015, US money and credit markets will be on the path toward normalization after seven years of abnormally low rates. This is a sign that, despite the weakness in other developed and emerging economies, the US is back on the road to normal growth.
However, the key indicator to watch will be the rate of growth of bank credit. The US is the only major economy where bank credit growth has returned to normal (6% to 8% per year), and it is critical that, in the aftermath of interest rate hikes, credit continues to grow at roughly the same rate. If this happens, then equity and property markets can shrug off the early phase of interest rate hikes, in my view. Assuming no tightening of credit conditions, I expect US real gross domestic product (GDP) growth in 2016 of 2.6% and Consumer Price Index (CPI) inflation of 1.4%.
UK on a delayed path to raising rates
The UK is faced with a similar situation to that in the US — reasonably buoyant economic activity (I forecast 2.4% growth in 2016), but accompanied by inflation well below target. This implies that the Bank of England (BoE) is unlikely to follow the Fed in raising interest rates until February or May 2016 at the earliest.
The eurozone and Japan continue QE
By contrast, the eurozone and Japan are still in the midst of extended programs of quantitative easing (QE) intended mainly to keep interest rates low along the length of the yield curve (rather than directly to boost the rates of growth of money and credit), and hence to stimulate the two economies.
With the euro area likely to grow at only 1.5% in 2016, and Japan at 1.3% — and with inflation in both economies well below 2% — the European Central Bank (ECB) and the Bank of Japan (BoJ) are at least a year, if not more, from hiking interest rates, in my opinion. In both cases, there are faults in the design of their QE programs that need to be rectified in order to make them more effective.
The upswing in the economies of both the eurozone and Japan have slowed somewhat in recent months, demonstrating that the underlying recoveries in the US and the UK are inherently more sustainable than the — as yet — fragile upturns in the eurozone and Japan.
Further volatility to come?
The divergent monetary policies of the Fed and possibly the Bank of England (BoE) on the one hand, and the ECB and BoJ on the other, imply some further volatility in the currency, fixed income and equity markets.
In particular, the US dollar will probably appreciate further while the euro and the yen might depreciate more. This may weaken the earnings of large US companies with substantial overseas sales, but medium and smaller-size US companies should benefit from the broadening domestic recovery.
The overall picture globally is one in which both growth and inflation will remain subdued against a background of several years of very low money and credit growth.
Emerging economies face three key problems
In the emerging economies, the slowdowns in China, Brazil and Russia are continuing to impact commodity markets, numerous basic industries and global trade volumes. Beyond that, the struggle among emerging market producers more generally to regain competitiveness threatens several emerging market currencies with the need for further currency depreciation.
The emerging economies face three key problems. First, many of them allowed excessive rates of growth of money and credit from 2009 to 2013; second, most are still overly dependent on an export-led growth model; and third, many of them are very dependent on commodity exports at a time when commodity prices have slumped.
Following the temporary recovery in the price of oil between March and May 2015 to $60 to $65 per barrel, prices fell again in the third and fourth quarters of 2015, with the West Texas Intermediate oil price falling below $40 per barrel in December. I believe that oil prices will remain weak (below $60) in 2016.
The current global business cycle expansion looks to be an extended one
Inflation rates have continued to remain very low in most developed economies. The widespread inflation undershoot reflects not only the direct effect of weak commodity prices but also the persistent background of slow money and credit growth that has characterized the post-crisis period. Only in the US have money and credit growth rates returned to normal rates.
In spite of these short- to medium-term setbacks in the recovery process, my long-standing view has been that the current global business cycle expansion will be an extended one. The main reason is that sub-par growth and low inflation would avoid the need for the kind of tightening policies that would bring an early end to the expansion.
It is also the case that recessions or growth weakness in the emerging market economies are unlikely to derail the modest-paced recovery in the developed economies. While some companies or sectors cannot avoid being affected by the problems of the emerging markets, the transmission of key fundamental forces — like monetary policy and balance sheet repair — still goes primarily from developed markets to emerging markets, not vice versa.
In addition, the recovery in the US, although already 6½ years old, is only now starting to take on the typical characteristics of a normal recovery: Banks have started to provide credit instead of the Fed, business investment is recovering, and consumer spending is regaining its normal momentum.
Read John Greenwood’s full 2016 economic outlook here.
Read more in our 2016 investment outlook series.
Important information
All data provided by Invesco unless otherwise noted. Data as of Dec. 16, 2015, unless otherwise noted.
Stocks of small and mid-sized companies tend to be more vulnerable to adverse developments, may be more volatile, and may be illiquid or restricted as to resale.
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
