Key views
- The U.S. economy continues expanding at a moderate pace. The first quarter wasn’t as weak as the GDP number suggests, and in the second quarter economic activity has picked up further. Payrolls and unemployment have progressed faster than expected, whereas core inflation has risen through May.
- My view is that the Federal Reserve will raise the policy interest rate earlier than previously thought— between March and June of 2015, instead of keeping it at zero through 2015:Q3. This tightening, however, will not come as a surprise, as I think the Federal Reserve will change the language of its statements well ahead of any interest rate hike. The tapering of asset purchases will continue apace through October 2014, more or less.
- Eurozone inflation might have stabilized, albeit at a dangerously low level. The European Central Bank is likely to announce a modest asset-purchase program in the next few months. I don’t expect this hypothetical program, or the measures announced in early June, to lift inflation or credit growth significantly. In any case, I don’t think a possible bout of deflation would last long.
- The United Kingdom is performing better than the rest of the G-7, in part because Britain had more catch-up to do. Faster credit growth and rising real estate prices are propelling the recovery, but might also force the Bank of England to tighten monetary policy soon. Scotland’s referendum for independence, according to opinion polls, will come to naught.
- Inflation in Japan is likely to fall short of the central bank’s target. The yen has not depreciated meaningfully for over a year. The higher inflation rate has failed to raise nominal wage growth, without which the reflationary process cannot be sustained. The Bank of Japan might ramp up asset purchases soon— ostensibly to offset tax hikes in 2014 and 2015, but in reality to mask the failure of Abenomics to fix Japan’s fiscal and growth problems.
- China’s sharp slowdown stabilized during the second quarter. The government has clamped down on shadow financing, which banks have partially offset with more regular lending. The property sector is cooling off, and defaults in the corporate and financial sectors have virtually stopped. Policymakers have introduced a host of small measures to provide targeted stimulus. The country is on track to meet the official goal of 7.5% growth in 2014, and I don’t think policymakers will rely on more borrowing to jumpstart the economy unless growth of 7% is at risk. The risk of a hard landing has diminished, but I believe China’s growth must decline to 4%-5%.
- In other developing countries the medium-term outlook is mixed. The fate of much of Asia Pacific and Latin America is tied to China’s. Slowdown in the Middle Kingdom hurts the suppliers of commodities, as well as trade-driven Asian countries. Other emerging countries will benefit from the cyclical recovery of the U.S. and the eurozone. Of the ‘Fragile Five’, Turkey and India face the brightest outlook.
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