Market Bulletin - Growth and 'Grexit'
Markets weaken as Greece continues to cast a shadow over optimism for the global recovery.
The International Monetary Fund (IMF) was optimistic about the prospects for global recovery in the latest World Economic Outlook, its biannual forecast. “There is no reason for gloom and doom,” IMF chief economist Olivier Blanchard told reporters. The organisation suggested that the world is finally shaking off the effects of the 2009 financial crisis.
The global economy should enjoy a reasonable recovery over the next two years, the report said, helped by the recent falls in energy prices and exchange rate movements. It believed that the rise in the US dollar and Chinese renminbi against the yen and the euro would help exports and growth in Japan and the eurozone, where interest rates are already so low they can’t be lowered any further.
The IMF is now predicting 3.5% global growth in 2015 and 3.8% in 2016. That compares with last year’s 3.4%. It singled out the strength of the US and UK economies while pointing to greater weakness in the eurozone, China and Latin America. Inflation, it added, had fallen everywhere. Since the beginning of the year, 26 central banks have responded by cutting interest rates, making an international total of 569 rate cuts since Lehman Brothers collapsed in 2008.
G20 finance ministers and central bankers, who gathered at the IMF and World Bank spring meetings in Washington DC last week, were also upbeat about the outlook for global growth, at least in more developed economies. They noted that the near-term prospects in the euro area and Japan had improved recently, while the US and UK continued to record “solid growth”. However, they lamented the current weakness in emerging markets.
The IMF forecasts that the US will be the fastest-growing of the advanced economies this year and next, growing by 3.1% in each of them. The US dollar, overall, continues to reflect this strength. At the beginning of January, one euro was worth $1.20; but by the start of last week it was dramatically down, at $1.05. Euro area economic weakness was a contributor, but the biggest single reason has been the expectation of a June interest rate hike by the US Federal Reserve.
Poor economic news raises the likelihood that a rate rise might be delayed, making the dollar less attractive. Last week’s run of disappointing data made investors fear that the US economy had yet to move past its first-quarter slowdown. The Empire State Manufacturing Survey for March was well below forecasts, revealing a sharp contraction in new orders. Industrial production suffered its largest drop since August 2012. March retail sales were lower than expected. By Friday, the dollar had fallen to $1.08 against the euro. It was then helped by news of a small rise in annual inflation to the end of March (1.8%, compared with February’s 1.7%) and finished the week at $1.07. The S&P 500 index ended the week down 1%.
Over and out?
Anxiety levels over Greece rose once again, with receding confidence in a speedy resolution to its economic problems and the heightened possibility of an exit from the eurozone. The catalyst was a media report that Greece had unofficially requested a delay for a month-end payment due to the IMF. Equity markets fell on the news. Christine Lagarde, head of the IMF, dashed any hopes of a grace period, saying that on the rare occasions such delays had been granted to others, they were “not followed by very productive results”. The yield on 10-year German government bonds hit a record low of 0.085%, while Greek bonds maturing in 2017 soared 4 percentage points to 27.9%, the highest level since 2012.
Germany’s political attitude appears to be hardening in the light of what it sees as Greece’s failure to put forward comprehensive reform proposals in return for more bailout money. Finance minister Wolfgang Schäuble ruled out a compromise deal, and one European diplomat told reporters that Berlin was “more prepared to let Greece go” than the rest of Europe might believe. If no more bailout funds are released, Greece is likely to default on a larger IMF payment due in mid-May. That would greatly increase the likelihood of a ‘Grexit’. Continental bourses had their worst week since January, and the FTSEurofirst 300 Index fell 2.3%.
On the other side of the world, the Chinese economy continues to lose momentum, as shown by the latest GDP growth figures. It grew by an annual 7.0% in the first quarter, compared to 7.3% in the fourth quarter of 2014. This reflected a slowdown in both construction and manufacturing, though not in services. The economy has been slowing every year since 2011, and this has been the lowest quarterly growth since 2009. Interest rate cuts and measures to encourage bank lending have boosted the economy less than hoped, apart from exciting the stock market, and so more stimulus is expected soon.
The slowdown is a necessary consequence of a planned shift in the economy from export industries to domestic consumption and services. The government is keen nonetheless to avoid an abrupt falling off and has targeted growth of “around 7%” for this year. The IMF is forecasting Chinese growth of 6.8% in 2015 and 6.3% next year. That would put China some way behind India, for whom the IMF predicts 7.5% growth in both years, up from 7.2% in 2014.
The last UK inflation and unemployment figures before the general election have been published. In the three months to February, unemployment fell to 5.6%, the lowest level since July 2008. Average weekly earnings grew by 1.8% compared with the same period a year earlier. Cheaper oil and food and cheaper imports combined to maintain inflation in the year to March at 0% – not quite deflation, but the joint lowest annual rate on record. The FTSE 100 Index reflected global equity weakness and closed the week 1.3% lower.
“The very low rate of inflation in the UK is not unusual in an international context, as currently 70% of developed economies have inflation below 0.5%,” said RWC Partners’ Ian Lance. He added that this was usually an environment in which equities would perform poorly, but their recent strength owed much to supportive actions of central banks. The continued threat of deflation does, however, make some shares more attractive than others, Lance said. “We favour companies – such as Sky, the satellite broadcaster – which have very strong pricing power and can produce profits growth even in a weak economic environment.”
Back at the hustings...
The IMF says that the UK economy will grow by 2.7% in 2015, compared with 2.6% last year, though easing off to 2.3% in 2016. As the UK general election draws nearer, the IMF’s Ms Lagarde struck at both major parties when she said that, whoever won, neither could balance the books by 2020. A day later, she said that the UK’s economic growth was “holding strongly” and that it was “obvious that what happened in the UK has actually worked”. Separately, German finance minister Schäuble said “the UK has done a very good job in the last few years and Osborne has a very good plan for the future”.
As the political parties add more detail to their tax policies, the Conservatives effectively promised to remove houses worth up to £1 million from the Inheritance Tax (IHT) net. This would be achieved by adding a £175,000 family home allowance to the existing £325,000 IHT nil-rate band. The £500,000 total would be doubled up for a married couple. Whilst welcome news, the proposals would only benefit combined estate values within a relatively narrow band between £650,000 and £1 million, and certainly does not remove the need for careful IHT planning. The increase would be funded by restrictions on pension tax relief for those earning more than £150,000. The common theme of cuts to tax benefits on pension contributions means individuals may wish to consider taking early advantage of current rules.
RWC Partners is a fund manager for St. James’s Place.
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