For the first time since the 2008 financial crisis, the global economy is experiencing a period of global reflation, which is: economic growth and inflation.
One of the benefits of global reflation is stronger corporate earnings. Not only are analysts seeing rising earnings in the US, they are seeing rising earnings in Europe and Japan. Analysts have become increasingly upbeat about corporate earnings in Europe, Japan, emerging markets, since late 2016.
Global earnings are collectively posting some of their best performances, since the end of the financial crisis. This trend should be maintained as world growth maintains momentum. Japan’s corporate earnings are particularly impressive, in that in the final quarter of 2016, pre-tax profits rose 11% on the year, to the highest level in a decade.
Global reflation is also driving the fixed interest markets, particularly in the US. Global reflation has resulted in the expectation that US interest rates will rise sooner rather than later, therefore, the bond yield curve has steepened. This has benefited the banking sector, with net interest margins widening, thereby boosting profits.
Federal Reserve (Fed) Chair, Janet Yellen, has signalled that US interest rates should rise in March. Speaking before Congress, she said that it would be “unwise” to wait too long before raising interest rates again as it could push “the economy into a recession”, although she stressed increases in interest rates would be made at a slow pace. In December last year, the Fed indicated that they would raise interest rates three times in 2017.
Donald Trump is implementing his electoral promises and immediately withdrew the US from the Trans-Pacific Partnership (TPP), which is a trade agreement including most of the major economies in the Pacific region, with the exception of China. Donald Trump also wants to renegotiate the North American Free Trade Agreement (NAFTA). Donald Trump’s protectionist policies are one of the main risks to the consensus of global reflation.
The US economy should benefit from Donald Trump’s proposed tax reforms and significant increase in fiscal expenditure; although there is some uncertainty as to whether he will get full backing from both Congress and the Senate. Although both houses have a Republican majority, many did not support Donald Trump during the election campaign.
The UK economy is also showing positive economic signs, with unemployment between October and December 2016, hitting an 11-year low at 4.8%. The employment rate also hit a new all-time high of 74.6%, as the number of people in work rose by 37,000. The unemployment rate in the United Kingdom has averaged 7.1% from 1971 until 2016.
The CBI Manufacturers’ Survey reaffirms positive economic trends, with manufacturers’ order books at high levels, although companies are planning some price increases.
UK inflation, as measured by the Consumer Prices Index (CPI), rose 1.8% in the year to January 2017, continuing its upward trend. The main reason for the increase was higher costs for food and fuel prices. This is the highest CPI has been since June 2014.
On the other hand, UK wage growth for the 3 months to the end of December 2016 was 2.5%. This means the gap between wage growth and inflation has narrowed. This suggests that household spending, in the current year, could be squeezed. Wage growth has, however, slowed from 2.8% in the 3 months to the end of November 2016.
Although the UK economy remains relatively strong, there are some worrying signs, in that retail sales volumes dropped by 0.3%, compared with the previous month, well below analysts’ forecasts of a 0.9% rise. The data indicated the first signs of a fall in the underlying trend, since December 2013.
Ruth Gregory, from Capital Economics, said, “January’s surprise fall in the official measure of retail sales volumes has brought the recent run of resilient economic news to an abrupt end. And the rest of the year is shaping up to be tough on the high street, given the expected squeeze on consumers’ real pay growth.”
The problems with Greece are beginning to resurface in the news. The Greek economy shrank in the fourth quarter in 2016, by 0.4%. Greece is in negotiations with the European Union to agree the next phase of Greece’s £73 billion bailout programme. The International Monetary Fund (IMF) is reluctant to get involved; because the IMF believes Greece should deepen and accelerate their economic reforms, whilst receiving further debt relief, which should allow the Greek economy to return to a sustainable growth path. There continues to be opposition to debt relief from the Eurozone.
Political risks also remain a feature within Europe. The Dutch General Election will take place in mid-March and this will be followed with elections in France and Germany. Anti-European Union political parties are expected to do well in these elections. It must be pointed out that following the political shift that occurred in 2016, namely Brexit and the election of Donald Trump, stock markets have risen, therefore, if the unexpected happens, politically, it may not lead to a collapse in markets, although the risks remain.
On the positive, the European Union have agreed a trade deal with Canada. It means that 98% of tariffs between the European Union and Canada will be removed.
In Germany, the Markit’s Purchasing Managers’ Index for manufacturing, which accounts for about a fifth of the economy, rose to 56.4 in January 2017, from 55.6 in December 2016. This was the highest level since January 2014 and it is above the 50 line, that separates growth from contraction, for the 26th consecutive month.
Although the Japanese economy managed to expand for the fourth consecutive quarter for the period ending December 2016, growth has softened, because of stagnating private demand. However, the weakening of the Yen and a pickup in global trade are propelling exports, which in December recorded their first positive reading in 15 months. Although the US has withdrawn from the TPP trade deal, Donald Trump is seeking a bilateral trade agreement with Japan.
Although the TPP trade deal did not include China, one of the key risks to the Chinese economy is a trade war with the US. It is too soon to say whether this is a likely event, but there have been a few tensions between Donald Trump’s administration and the Chinese regime. Protectionism will hurt both US consumers and Chinese producers.
Donald Trump’s relationship with China may have a big impact on global trade and financial markets, as China is a big holder of US debt. As at 31 December 2016, China held $1.1 trillion US Treasuries, making China the second largest holder behind Japan.
Emerging markets, who are net producers of oil and other commodities are benefiting, overall, from rising oil and commodity prices. As a result of these trends, both Brazil and Russia should emerge from their recessions during the current year.
Since the financial crisis, global economic growth has been subdued, with extremely low inflation, wage growth and interest rates. Although it is early days, we could be experiencing a change in trend, in that the global economy could be experiencing stronger economic growth, together with higher inflation and ultimately higher interest rates. There are risks to this new economic scenario and these include Donald Trump’s protectionist policies, the level of debt (particularly within the developed economies), political risks (particularly in Europe) and a financial crisis within the Eurozone.