Global activity picked up modestly since Labor Day, helped by an increase in Chinese activity and further stabilization in Europe. Nonetheless, world trade has been stagnant for almost two years, prompting a lively debate about whether this is a ‘new normal’. Some commentators argue that in the decade preceding the financial crisis, a series of ‘one-off’ factors – including the integration of China and Eastern Europe into the global economy – temporarily boosted world trade and these factors are unlikely to be repeated anytime soon. Still, it seems the recent weakness also has a powerful cyclical component, particularly the sluggishness of the euro area, which accounts for a large share of world trade.
We believe there will be a tangible US recovery in 2014 once the large fiscal tightening is over, but that may not occur until February. One reason the economy has been well supported is that easy money from the Fed has boosted household spending on housing and consumption. This has offset much of the fiscal tightening. Unfortunately, higher health insurance spending because of the Affordable Care Act may remove money from consumers’ pockets and dampen retail/holiday spending. Prepare to see economic progress sometime after the first quarter of next year.
In Europe, euro-area inflation has dropped sharply over the past year, triggering renewed pressure on the European Central Bank to cut interest rates. Meanwhile, we forecast only modest European growth in the months ahead. German growth looks solid, but the rest of the region is struggling. In September, euro-area unemployment reached a record high of 12.2% and jobless rates remain at depression levels across the euro-area periphery. Though financial markets continue to believe the worst of the euro crisis is over and government bond spreads have tightened considerably over the past 18 months, unemployment at these levels remains a genuine threat to the economic and social stability of the region.
In China, there was a strong message from the Third Plenum (a closely watched government get-together that sets policy direction): economic reform is on the way. The communiqué was short on details, but three themes clearly came through:
- Expect crucial financial reforms: liberalizing interest rates and permitting capital flows to allow the market to play a decisive economic role
- Do not expect political reform in the sense of changing the status quo for the Communist Party
- Do not expect near-term change to state-owned enterprises
Importantly, President Xi has consolidated power and has a plan to implement reforms. This may be a watershed moment. The communiqué stressed that the Shanghai free trade zone – the pilot for opening up the financial sector – has to be extended to other areas fast. This is good news; once you let the market’s foot in the financial sector door, it will be extremely hard to go back. The lack of state-owned enterprise reform is not particularly disappointing since once the market is allowed to set interest rates and allocate domestic resources, their game is up. The predominant message is that the market will play a key role in allocating resources in the economy.
Michael Ashley Schulman, CFA