Vol 10 (2013) - Issue 1

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2013: Eight Themes

1. Global growth stays moderate, dominated by structural re-balancing changes, but led by Emerging Markets (EM). We project global growth to remain in the 3-3.4% range, with EM representing half of the global economy and contributing 3/4ppt of total growth. Advanced economies continue to de-lever, but encouraging signs are emerging. Private sector de-leveraging has made significant strides in the US, while public sector de-leveraging is only starting. Public sector de-leveraging continues to dominate the Euro area, but the impact will be less severe this year than in 2012.
2. Central bank bond purchases lessen the tail risk. Quantitative easing remains the principal monetary policy framework for advanced economies, while EM economies navigate the course between limiting currency appreciation and the need for maintaining a stable inflation outlook.
3. Commodity prices are set on moderate trend. Global growth is one of the key factors determining commodity prices and moderate global growth suggests an easing of prices to a more sustainable trend than what had been the case in the recent past.
4. The US and the fiscal headwind – not the cliff. Congress passed the American Taxpayer Relief Act of 2012 on 1 January 2013. The main provisions of the bill are well known, notably the permanent extension of the “Bush tax cuts” for incomes below USD 400/450K. The relief for The Alternative Minimum Tax is also permanent. For businesses, we note the one-year extension of the bonus depreciation, a plus for investment spending. Decisions on automatic spending cuts and the debt ceiling increase were postponed for two months.
The focus of policy is on near-term growth rather than aggressive deficit reduction measures. The fiscal drag represents a manageable 1% of GDP this year, largely concentrated in the first half. We welcome this dynamic for two reasons: a) a more aggressive fiscal consolidation would have given the economy a major negative blow at the crucial time when the deleveraging of the household sector has improved significantly and the housing sector is recovering; and b) the bill is not inconsistent with the enactment of a gradual and longer-run deficit reduction package. Fiscal policy will still shave off about 1ppt of GDP this year.
The postponement of spending cuts for only two months does not eliminate uncertainty regarding the conduct of fiscal policy or enhance the chances of a quick compromise. As such, market volatility will return and the outlook remains uncertain for business investment spending and we still anticipate the recovery in investment spending to be skewed toward the second half of the year. This dynamic will keep employment growth gradual.
The rating agencies may run out of patience with the uncertain fiscal outlook, with the US remaining vulnerable to a potential downgrade.
The still uncertain longer-run fiscal path ensures the continuation of a pro-active Fed and very low interest rates.
5. The US and the private sector improvement. The US economy will increasingly benefit from less aggressive de-leveraging of the private sector (households and banks), still elevated profit margins, the recovery in housing, an efficient manufacturing sector, and a buoyant energy sector.
Household debt has declined from a peak of 98% of GDP in 2009 to 81% in Q3:12, while the debt service ratio (as measured by household debt service payments and financial obligations as a percentage of disposable personal income) has declined from a multi-decade high of 14% in 2007 to 10.6% last year. The financial sector debt ratio has declined from 123% of GDP in 2009 to 87% last year.
Corporate balance sheets remain very strong and we anticipate another year of elevated profit margins, as unit labour and non-labour costs (interest costs) remain low. Only when wages start to rise and the labour market has fully recovered will margins decline. Furthermore, our expectation of investment spending recovering in the second half of the year when more clarity regarding fiscal policy sets in should not dampen margin significantly.