Macro View: Global markets witness big setbacks as yields fall

GLOBAL markets saw dramatic setbacks between mid-September and mid-October, largely reflecting pessimism over growth prospects. Share prices, which earlier in the year were at all-time highs, fell by 10-15% in this period, with Europe suffering the worst declines.

Fears over weak growth were reinforced by yield falls in “core” government bonds. Yields on ten-year German Bunds and US Treasuries were more than 100 basis points lower than early in 2014. The fall in US yields was surprising, given the strength of the US economy and the Federal Reserve’s policy of ending its asset purchase programme. Declines in oil prices, in spite of tensions in Ukraine and the Middle East, added to fears over growth. Brent crude fell by more than 25%, from a peak of $115/barrel in June 2014 to below $85/barrel early in October.

While the market upheaval was violent, some of its effects were reversed quickly. By early November, US share prices more than recovered their losses and reached new highs. But it would be complacent to conclude that the recent rout was a trivial blip.

European stock markets regained only part of their losses and still show net falls. Bond yields remain below their mid-September levels, even in the US. Oil prices fell further, to their lowest levels in three years, reinforcing perceptions of weak demand.

While the markets’ mood improved, and fears of a new upheaval receded, fears over global growth became more entrenched. Growth forecasts have been revised down, for the global economy as well as for all major countries and regions other than the US. Given this, the recovery in share prices may well be built on shaky foundations, because it was only made possible by actual and prospective big new injections of cheap money. But there are growing concerns that the huge monetary stimulus administered by the major central banks since 2009 is no longer helping and may become damaging – as it creates distortions, heightens uncertainties, and paralyses the willingness to take risks and invest.

China’s GDP grew by 7.3% year on year in the third quarter of 2014, its slowest pace in more than five years. Though the figure was slightly higher than expected, the downward trend is unmistakable – as the economy copes with a falling real-estate market, weak domestic demand and slackening industrial production. In spite of mounting problems, the Chinese economy is unlikely to suffer a banking collapse and a recession. But GDP growth will slow further, from 7.7% in 2013, to 7.3% in 2014 and 6.9% in 2015, lower than previously expected. Indeed, many economists believe that the official figures overstate the true pace of Chinese GDP expansion, and there is a distinct possibility that the slowdown in Chinese growth over the next few years may turn out to be even sharper than is currently envisaged.

Better prospects
Among the G7, US growth prospects are better than in the eurozone and Japan. The US is doing better than anticipated earlier in the year, when severe weather conditions triggered a temporary GDP fall. The US economy will still be affected by the weaker global outlook, and performance is mediocre by historical standards, but there is gradual progress. US GDP grew by an annualised rate of 3.5% in the third quarter of 2014, below the 4.6% growth in the second quarter but better than most analysts had expected.

The recovery is broadly based, reflecting stronger household consumption, exports and investment. In contrast to weaker growth expected elsewhere, our US growth forecasts are being raised, to 2.2% for 2014 and 2.8% for 2015. The US economy created 214,000 new jobs in October, slightly fewer than expected, but a robust labour market. The jobless rate fell to a six-year low of 5.8%. But the housing market is softening. Year-on-year growth in US house prices slowed for the eighth month in a row, to 5.1% in August, after 5.6% in July, well below annual rises in excess of 10% in the early months of 2014. Although the US Fed ended its asset purchase programme in October, as planned, policy makers will tighten policy only cautiously. We expect the first increase in the Fed funds rate to occur in the second quarter of 2015.

Eurozone growth prospects are worsening, and there is worrying evidence that the powerful German economy is weakening. Retail sales in the 18-country eurozone fell by 1.3% in September, with Germany recording the biggest fall in sales, of 3.2%. Growth forecasts have been cut markedly, not only by private sector economists, but also by more cautious official organisations such as the IMF and the EU Commission. Our eurozone GDP forecasts are revised down, to 0.7% for 2014 and 0.9% in 2015. The fact that growth is expected to remain below 1% for two years in a row, after an outright fall in 2013, will increase pressures for policy changes. German growth, the eurozone’s traditional driver, is being downgraded, reinforcing concerns over the region’s prospects and the euro’s long-term survival as a single currency.

There is no immediate sense of crisis, but the situation is difficult. Eurozone unemployment is still stuck at 11.5% of the workforce, almost double the rate in the US and the UK, and only slightly below the 12% all-time high. Annual inflation is marginally up, at 0.4%, but still well below the official target of just under 2%. Pressure on the ECB to take stimulatory measures remains strong, and president Draghi seems keen to act. But German hesitation is so far a restraining factor.

The contrast between the Fed’s gradual moves towards tightening, and the easier stance of other central banks has triggered further rises in the dollar. The yen fell to a six-year low against the US currency, as the Bank of Japan surprised the markets with a further huge dose of stimulus, in order to fuel inflation and support growth. In Europe, the ECB has not yet decided to buy government bonds, but expectations that such a move may prove unavoidable pushed the euro to a two-year low versus the dollar. Even sterling fell to a 14-month low compared to the dollar, as the markets altered their earlier view that the UK would shortly raise official rates. With signs that UK growth is slowing, a rise in UK Bank rate is now unlikely until well into 2015.

David Kern of Kern Consulting is Chief Economist at the British Chambers of Commerce. He was formerly NatWest Group Chief Economist