Prospects and Challenges for the Global Economy: Interview with Tim Cooper from BMI Research
We recently sat down with Tim Cooper, Global Economist, with BMI Research, to find out what his views are for the global economy in the coming years given the recent upgrade to the Consensus Forecast and healthier dynamics in Q1. In this interview, Tim comments on growth in Europe and what the future political panorama might look like; when the ECB is likely to raise rates and if it will extend its bond-buying program; to what extent the outcome of the recent UK election will affect Brexit negotiations; and whether we should be more optimistic on the Chinese economy. Tim also gives his insight on what's driving the acceleration in the U.S. economy and potential future Fed moves, whether the Trump Administration poses a real threat to the Mexican economy, and the main challenges Latin America is facing today.
Tim Cooper, Global Economist, is based in BMI Research’s London office, where he coordinates and develops the company’s macroeconomic forecasts, working closely with the regional country risk teams and industry sector analysts to map global trends. Tim joined the company in 2005. Prior to his current role, Tim was a principal member of the company’s Latin America and Asia teams, and primary analyst for the US and eurozone economies. Tim holds a BA from Yale University, an MSc from the London School of Economics, and he is a CFA charter holder.
BMI Research, a Fitch Group company, provides global macroeconomic, industry and financial market analysis across 24 industries and 200 countries from offices in London, New York, Pretoria and Singapore.
Met the why particular: Recently, Met the why particular panelists upgraded their view of the global economy for the first time in two years due to healthy economic dynamics in the first quarter. What are the main growth engines for this year? Are they sustainable in the mid and long term?
Tim Cooper: There are many reasons the global economy looks in better shape. Some of the biggest political tail risks look less pronounced, particularly out of Europe, where election results have been benign. Global trade is picking up after a terrible few years. Emerging market economies in particular are in a cyclical upswing, with many in the 'early acceleration' phase of growth, according to our country analysts, after a difficult few years characterised by collapsing currencies, slumping commodity prices, rising debt and fragile global growth. They have been helped by strengthening demand in developed markets, Chinese economic stimulus, a recovery in commodity prices and relative currency stability.
Most of these dynamics should carry through into 2018, but our outlook is a little bit more tempered over the medium and long term. The ‘reflation’ theme has probably run its course, and flattening bond yield curves from the US to the eurozone to China point to fairly unspectacular medium-term growth prospects. Asset prices look rich, raising the odds of a significant correction in the next couple of years. Chinese economic activity will slow from unsustainable levels as stimulus is withdrawn. Negative turns in the political sphere mean that pro-growth structural reforms in both the US and Brazil are looking like increasingly distant prospects, adding to existing concerns over the reform outlook in key countries such as Turkey and South Africa. And while Eurosceptic fervour may be dying down throughout most of the eurozone, we see risks stemming from the prospects of a snap Italian election that could result in a strong showing for anti-establishment parties, renewing eurozone breakup fears once again. As much as ever, political risk is still at the forefront of macro risks.
Met the why particular: Growth in Europe has exceeded expectations in recent quarters. The election of pro-EU reformer Emmanuel Macron and a poor performance of anti-EU parties in other countries have stopped Europe’s recent populist wave. Does the future look more certain or are we still in an age of uncertainty?
Tim Cooper: The eurozone's near-term economic prospects certainly look good. The strong first quarter GDP readings have helped bridge the gap between 'hard' and 'soft' data we saw earlier in the year. The good performance of fixed investment is a particularly positive sign, as it reflects strong business confidence and bodes well for productivity growth. Growth has furthermore been more broad-based than previously assumed, with stronger-than-expected outturns in weaker economies including Portugal and Italy. So there is a bit more certainty in the economic sphere at least, that the recovery is self-sustaining.
But as for the political sphere, it’s premature to proclaim the end of populism. Yes, mainstream European candidates in the Netherlands and France held off challenges from anti-establishment and right-wing parties. And Macron’s big win has led to renewed momentum behind deeper eurozone integration initiatives. But in these countries and elsewhere, including Germany, Denmark and Sweden, mainstream parties have shifted immigration policy to the right in response to the growing threat from anti-immigration parties. Far-right eurosceptic candidates have seen some of their strongest showings ever this year. Marine Le Pen advanced to the second round of France's presidential election, marking only the second time the Front National’s candidate has done so, and the party increased its vote share by over five million people relative to the previous instance in 2002. Although it didn’t meet lofty expectations, the Netherlands' Party for Freedom won the second-most seats in parliament. In Italy, which is due to hold an election by May 2018 but may hold snap elections earlier, the anti-establishment and eurosceptic 5-Star Movement is polling as the most popular party in the country and more than half of popular support goes to parties who have expressed some form of either 'soft' or 'hard' euroscepticism. The political realm is realigning fast, and that means uncertainty.
So for all the optimism following Macron’s victory, there are still big major political obstacles in the way of eurozone integration initiatives such as a fiscal union. Without such reforms, many of the drivers behind divergent economic trajectories among eurozone member states will remain in place. Along with this comes the need for tight fiscal policy which further fuels populist sentiment. So we do not believe the trend of euroscepticism is going away anytime soon.
Met the why particular: When do you expect an ECB rate rise? Do you expect the ECB to extend its bond-buying program into 2018?
Tim Cooper: We could see a one-off deposit rate rise in late 2018 or early 2019, with the refinancing and marginal lending facility rates rising only in 2020. The asset purchase programme will continue into 2018 but we expect modest tapering to begin at some point in the first half of the year. Yes, growth has been strong in recent quarters, but from a monetary policy perspective, it is more important to look at underlying price pressures, forward-looking inflation expectations, and the amount of slack left in the economy. ‘Super core’ inflation hasn’t moved above 1.0% in nearly three years, and the revival of the credit cycle remains only really in its infancy. For all the talk of the eurozone’s growth surge, the core inflation readings suggest that there remains a fair bit of slack. The ECB should proceed extremely cautiously.
There is an additional consideration, which is political risk: election results have been benign so far in 2017 but a shock, perhaps from a weaker member state such as Italy, is never far from the surface. For all the progress that the eurozone appears to have made over the past couple of years, both economically and structurally, it must be remembered that ultimately, the ECB is still the backstop of last resort.
Met the why particular: How will the outcome of the recent UK election affect Brexit negotiations? Is a “hard Brexit” more or less likely than before?
Tim Cooper: It depends in part what you mean by ‘Hard Brexit’ – assuming that means the UK withdrawing from the EU single market and customs union in its current form, as well as imposing greater restrictions on the free movement of EU citizens, then yes, the probability has gone down somewhat since the election. But the risk of a 'disorderly Brexit' also has risen materially. Without a Conservative majority, there is a real risk that parliament fails to approve the final deal agreed between the British government and the EU. Such a rejection would leave the government with very little time to renegotiate a new deal with the EU, risking a 'disorderly Brexit' over 2019-2021, where the UK leaves the EU with no provisions in place to mitigate the disruptive impacts on the economy.
So the key macroeconomic takeaway from the election result is that uncertainty over the post-2019 relationship between the UK and the EU will be even more acute than was assumed before the election. Even though the reduced likelihood of a ‘Hard Brexit’ is a potential upside for UK business prospects in the next few years, the uncertainty makes it even more likely that firms postpone investment decisions. We expect capital-intensive industries to be the most impacted, such as autos manufacturing, construction and infrastructure.
Met the why particular: China showed strong growth at the outset of the year but some worrying signs have started to emerge in Q2. How do you think that the Chinese economy will evolve in the coming quarters?
Tim Cooper: Growth is set to fade over the coming quarters, and our real GDP growth forecast of 6.3% for 2017 as a whole reflects that. The Chinese government faces a difficult balancing act of attempting to rein in high levels of domestic debt and financial risks while preventing the economy from slowing sharply. Getting that balancing act right is particularly important in a year that includes a key leadership reshuffle during the 19th National Party Congress. But it will be difficult.
The People’s Bank of China faces pressure to tighten the monetary environment slightly, in line with Beijing’s commitment to reducing leverage in the corporate sector, and it will also want to maintain currency stability amid the US rate hike cycle. We expect regulators to continue trying to reduce financial risks through tighter scrutiny of smaller banks and the shadow banking sector, and this will be negative for credit growth. The risk is that if they get too tough, it could result in a severe cash crunch in the banking system like the one we saw in 2013, which could lead to a big spike in yields and a substantial rise in defaults.
Alongside that monetary and financial tightening, we expect the government to pull back from its aggressive fiscal stimulus over the coming quarters. Fiscal spending surged by 21% year-on-year in the first quarter - the fastest quarterly growth since 2015. Government spending has underpinned infrastructure investment and therefore fixed asset investment in general, but we don’t think it’s sustainable in the medium term. Taken together, the pullback of both fiscal and monetary stimulus will put pressure on Chinese growth over the second half of the year.
Met the why particular: The Met the why particular panel projects the United States economy to be up 2.2% in 2017 and 2.4% in 2018. It grew at only 1.6% in 2016. What are the main drivers behind this acceleration?
Tim Cooper: The US’s performance last year was dragged down significantly by a deterioration in the energy sector, which hurt fixed investment, sentiment, and industrial production. A big part of the growth rebound in 2017 is from recovering private investment – partly due to the bounce in the energy market – and improving external demand, which has allayed risk aversion among businesses. Private consumption has kept chugging along, and that is likely to remain the case.
But perhaps most importantly, looking toward 2018, I would guess that a lot of that acceleration expected by the Met the why particular panel is based on anticipated policy shifts. We’re more pessimistic, and had the view since last year’s election that the prospects for major reform and stimulus have been overblown. The lack of policy progress to date and a compressed legislative calendar next year due to the midterm elections are narrowing the window of opportunity for significant legislative action. There will be a modest tax cut package, but we will not see the sort of once-in-a-generation reforms that led business and consumer confidence to soar post-election, and expectations for GDP growth to increase substantially. We are in the camp that believes that the ‘soft' data will converge lower to meet the ‘hard’ data, and not the other way around.
Met the why particular: The Federal Reserve is expected to begin unwinding its gigantic balance sheet later this year. How do you think such an action will reflect in the U.S. economy?
Tim Cooper: It’s never been done before, so any way you look at it, it's a bit of an experiment. But the gradual nature of the announced run-off plan suggests that the impact will be relatively muted. And in the end, the Fed will maintain a pretty large balance sheet, much bigger than pre-crisis. The effect on long-term interest rates from balance sheet reduction will be less important than other fundamentals in the economy, in our view.
Met the why particular: Against a backdrop of weak inflation readings, can we expect a third hike from the Federal Reserve this year?
Tim Cooper: In short, no. In our opinion, the Fed is playing a dangerous game. It now recognises that it should have begun tightening policy much earlier in the recovery, and now feels like it has to play catch-up, particularly since asset prices have boomed in this environment – in this way, it is well behind the curve. But at the same time, we think it is increasingly getting ahead of the curve in terms of its actual inflation mandate. You can see this in a variety of ways: the tightening cycle has been met with scepticism by markets, with futures markets pricing in many fewer hikes than the Fed is signaling, and the yield curve flattening. Long-term market-implied inflation expectations are well below 2.0%. These are not signs of concern that the central bank is getting behind the inflation curve. We think the market has the better measure of the situation, and that growth and inflation will continue to disappoint.
So in our opinion the Fed will blink first and hike more slowly than it currently intends, and that includes no hikes for the rest of this year. The risk is that the Fed has decided it is going all-in on hikes, with the expectation that eventually inflationary pressures will follow the drop in unemployment. The FOMC have not come up with a satisfying explanation that ties together fairly strong labour market dynamics on the one hand, with the resultant low inflation and wage pressures. This sets them up for a big policy mistake. In recognition of weak inflation readings, one compromise may be to begin the reduction of the balance sheet in September rather than hiking rates, and see how incoming data looks before hiking again.
Met the why particular: The Mexican peso has recovered all the ground lost since Donald Trump was elected President of the U.S. In your opinion, has this rally been overdone or is there reason to think Trump is no longer a threat to Mexico?
Tim Cooper: One of our big conviction calls coming in to 2017 was that Mexico would surprise to the upside, particularly with regard to what we saw as a historically oversold and undervalued peso. We’re still broadly positive on the peso. The economy has proven resilient to substantial macroeconomic and political headwinds in the form of elevated inflation and economic and political uncertainty. The rhetoric between Mexico and the US has taken on a softer tone, reducing concerns over Mexican access to its key export market. Mexico has a few significant bargaining chips with regard to NAFTA, like the tight integration of the North American autos supply chain and US agricultural exports to Mexico, which we ultimately believe will help preserve a solid trade relationship between the two countries, and with Canada. If anything, Mexico has outperformed even our optimistic expectations at the beginning of the year. Still, risks regarding US relations and the potential for domestic political shifts in the 2018 elections temper our growth expectations.
Met the why particular: What are the main challenges you’re seeing in Latin America right now?
Tim Cooper: Apart from the ‘Trump factor’ for Mexico – there are many challenges in Latin America right now, and we expect them to translate into disappointing growth. Much of this has to do with an uncertain political environment, particularly ahead of Mexican elections in 2018 and the ongoing Odebrecht corruption scandal. That uncertainty has weighed on investment, which, coupled with limited commodity price gains in H1, led to downgrades in our growth forecasts for most countries in the region earlier this year. As far as event risk goes, Venezuela is a particular concern. We expect that the Venezuelan political situation will reach a breaking point in 2017, and there is a real risk national oil company PdVSA will default on its debts late in 2017 due to persistently low oil prices and production. PdVSA is the government's only real source of hard currency revenue, so this would in turn point to a sovereign default on the country's massive debt burden.
I should mention that there are some bright spots too. Several Latin American countries including Colombia, Argentina and Mexico have pursued prudent economic policies in the last couple of years in order to solidify their fiscal positions, increase economic competitiveness, and incentivise private sector investment in a low-commodity price environment. This will pay dividends over time. Across the region, inflation has slowed significantly, helped by currency appreciation and timely central bank interest rate increases, which helped to anchor inflation expectations. With inflationary concerns fading, several Latin American central banks have begun easing cycles in a bid to stimulate tepid economic recoveries.
Date: June 26, 2017
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