The last 12 months have been characterised by political change, together with political uncertainty. The list is endless and includes new governments in the US and France, Brexit negotiations and the threat of war with North Korea. However, nothing seems to get in the way of the global economy. The Organisation for Economic Cooperation and Development (OECD) are forecasting that global GDP growth will be 3.5% in 2017 and 3.7% in 2018, up from 3% in 2016, and a slight increase on the OECD’s June forecasts.
In the second quarter, US GDP grew 3.1%, which was ahead of expectations, however, Hurricane Irma is expected to have a significant impact on September’s figures, although rebuilding may boost GDP growth in the fourth quarter and in early 2018.
Third quarter US corporate earnings are also expected to be much lower than the previous quarters. Less than a tenth of the companies within the S&P 500 have reported so far, but almost half of these companies have apportioned poor results to hurricanes.
The US economy is performing strongly with core retail sales up 1% in September, which is ahead of forecasts. US unemployment has fallen to 4.2% in September, which is the lowest point since February 2001.
Inflation in the US remains subdued and was again below expectations, with the core Consumer Price Index (CPI) up 0.13%, in September. Although inflation remains below expectations, the Federal Reserve (Fed) is still likely to continue its process of normalising interest rates. The Fed Open Market Committee has suggested that if the economic environment remains unchanged, a November rise is now inevitable.
Markets are now beginning to turn to Donald Trump’s tax reform agenda. If he is able to get these measures through Congress, corporate earnings in 2018 should be given a boost. It should also mean the repatriation of cash held offshore by American companies to avoid punishing taxes. Goldman Sachs estimates that S&P 500 companies hold $920 billion in untaxed cash overseas. If Donald Trump is successful, it could have a dramatic impact not just on the US economy, but also the global economy. The Fed is likely to inject more urgency into their rate tightening cycle, with interest rates rising at a faster pace, which will probably strengthen the US Dollar.
Janet Yellen’s term as the Fed’s Chairperson expires in February next year and it is rumoured that Donald Trump will seek a replacement. Donald Trump also has three other seats on the Fed’s board that he can fill with people of his choosing. This gives him massive influence over the form of US monetary policy for the medium to long term.
In the third quarter, UK GDP growth was 1.5%, which was lower than an expectation of 1.7% and the lowest economic growth within the G7. Despite this slowdown in growth, the National Institute of Economic and Social Research believes that growth may accelerate in the 2nd half of the year and the Bank of England Governor, Mark Carney, is discussing a potential interest rate rise. A few months ago the market was expecting UK interest rates to remain unchanged until 2019, but markets are now beginning to look for interest rates to rise as early as November’s Monetary Policy Committee meeting.
Inflation (CPI) rose 3% over the 12 months to September, which is a 5-year high. Inflation is higher than wage growth, which, for the three months to August 2017, rose 2.2%. This is affecting consumer spending and the domestic economy. The Brexit negotiations with the European Union are still not making significant progress, which is creating uncertainty in the domestic economy.
Although the domestic economy is showing signs of a slowdown, manufacturing companies are continuing to benefit from the weak Pound. Manufacturing production in the UK grew 0.4, month on month, in August, which beat the market expectation of 0.2%.
Europe’s economy is continuing to show signs of improvement and although unemployment in the Eurozone remains unchanged at 9.1% in August, the trend is still downwards. In the Eurozone, the Final Manufacturing Purchasing Managers’ Index (PMI) for September, was a very healthy 58.1. The German Manufacturing PMI was even stronger at 60.6. A PMI of more than 50 represents expansion of the manufacturing sector when compared to the previous month.
Political tensions are still prevalent in Europe, but so far they have had limited impact on markets. In Spain, the Catalan leader, Carles Puigdemont, and other regional leaders signed a declaration of independence from Spain, after the region’s ‘illegal’ referendum, showing overwhelming support to sever ties. However, they confirmed action on succession would be suspended to allow talks with the government in Madrid.
Japan’s snap General Election will be held on Sunday 22 October, with Prime Minister Shinzo Abe, of the Liberal Democratic Party, fighting the newly launched Party of Hope. If Shinzo Abe loses, the Governor of the Bank of Japan, Haruhiko Kuroda, may also lose his position, with his tenure coming up for renewal in April next year. Shinzo Abe and Haruhiko Kuroda are responsible for Japan’s economic policy of Abenomics. If both lose their positions, there could be a significant change in economic policy, with monetary policy tightening and the Yen strengthening.
Although a change in government could change economic policy, the Japanese economy should still benefit from strong global demand, corporate governance reforms and tighter labour markets. Tighter labour markets should drive efficiency improvements in Japanese companies. The market, however, expects Shinzo Abe to win the election and remain as Prime Minister.
Japan’s recent economic data has been disappointing. Retail sales dropped 1.76% (seasonally adjusted), month on month, in August, missing forecasts for a decline of 0.5% and substantially behind the 1.1% gain in July. GDP growth, for the second quarter, was also revised lower from 4% to 2.5%.
The big event currently taking place in China is the Chinese Communist Party Congress. This event will be closely followed by markets in that it will not only drive the Chinese economy, but also the global economy. Every five years, the Chinese Communist Party meets to reappoint its leaders and set out priorities for the next term. It will be the first conference run by President Xi Jinping and it is believed, overwhelmingly, that he will retain control by the end of the conference. New Chinese leaders tend to spend the first five years of control unpicking the tentacles of the previous leadership and consolidating power in order to carry out their agenda in their second term. Now that Xi Jinping has an iron grip on power, it is believed that he will start to steer the country towards his long-held goals: decreasing debt and increasing reform. If he is successful it should mean a reduction in economic growth, but if done well, that growth should be of much greater value to both China and the rest of the world.
One of the problems with the Chinese economy is that non-financial debt has risen at an alarming pace over the last decade, whilst economic efficiency has deteriorated. China’s state controlled economy has so far avoided any systematic crisis because most borrowing is passed between the state-owned banks, local governments and state-owned enterprises. Calling in debts would only mean passing assets from one hand to the other creating no benefit, only disruption. The side effects of this debt consist of asset bubbles in property and stock markets, as well as capital outflows. The balance between growth and stability is becoming increasingly precarious.
Recent economic data for China includes inflation (CPI) up 1.6% in the 12 months to September, which was in line with expectations. China’s Manufacturing PMI also fell to 51.0 in September from 51.6 in the previous month, missing a market consensus of 51.5. The economy is still growing, but it is the weakest expansion in the manufacturing sector since June.
If the global economy continues to expand into 2018, central banks will continue the process of tightening monetary policy, led, probably, by the US. The political events over the last 12 months have had minimal impact on the global economy, however, the political events in the next 12 months, led by the Chinese Communist Party Congress and Donald Trump may influence the global economy and markets. Although Donald Trump may have difficulty in implementing his tax reforms, he should use the opportunity to influence US monetary policy through his appointments to the Fed Board.