The world economy may be set for another year like 2015, with modest growth in developed economies offsetting persistent weakness elsewhere but generating very little inflation and keeping interest rates low.
The US Federal Reserve’s long-awaited rise in rates from zero showed confidence in the world’s largest economy, but rival China is still struggling for a foothold with rate cuts.
Although some countries, such as Brazil, have mainly home-grown inflation troubles, the Fed’s first post-crisis rate hike is an unlikely cure for what ails the rest of the world.
With exchange rates dominating the policy debate in many countries, what happens to the dollar will matter a lot.
“The key question is whether the US economy is finally robust enough not only to sustain its own recovery but also to lift world trade and global growth enough to allow the external deflationary pressures weighing on US inflation to wane,” outlined HSBC economists Janet Henry and James Pomeroy.
According to HSBC, the US, “via a strong US dollar, will simply become the latest victim of the deflationary pass-the-parcel which has plagued the global economy for a decade, and find itself following all of the other developed market central banks which raised rates but soon found they had to reverse course.”
“The outcome, we believe, is likely to be somewhere in between.”
Over the past year, global fund managers have cut their recommendations for equity holdings to near their lowest since the financial crisis, even as they ramped up bond holdings.
Crude prices
Since crude oil prices began falling sharply 18 months ago from above $100 a barrel to below $40 now, the number of analysts predicting a rebound has dwindled.
Some are now saying $20 is more likely than a sizeable move higher.
But there are some bright spots. Underpinned by the European Central Bank’s €60 billion a month of bond purchases, the Euro zone is finally generating modest growth and unemployment has begun to fall.
Inflation remains well below target, however, and so ECB stimulus, including the negative deposit rate, will remain in place for all of next year.
That puts the world’s largest trading bloc — and most other central banks — on an opposite policy path to the Fed.
Emerging markets
Some emerging market economies are performing better, too. India is forecast to grow at a decent clip, underpinned by rate cuts earlier this year during a window of low inflation.
And optimism about Mexico has grown as it slowly starts to take advantage of a recent historic reform in the energy sector.
But much can still go wrong. Food prices have already pushed Brazil’s inflation above 10 per cent during a deep recession and could rise further.
“As if predicting exchange rates and interest rates wasn’t hard enough, a strong El Nino may be arriving,” warned BofA-ML head of global emerging markets fixed income strategy, Alberto Ades.
“So economists and investors will need to keep an eye on the weather, too.”