A year ago, there was a pervasive mood of gloom among economists and investors about prospects for the global economy in 2016. China was in the doldrums, and fears of a sharp renminbi devaluation were rife. The oil shock had caused major reductions in capital spending in the energy sector, and consumers seemed reluctant to spend the large gains they were enjoying in real household incomes.
Deflation risks dominated the bond markets in Japan and the Eurozone. In the US, the Federal Reserve seemed determined to “normalise” interest rates, despite the rising dollar and the weakness in foreign economies.
At the turn of the year, there were forecasts of global recession in 2016. At the low point for activity and risk assets in 2016 Q1, the global growth rate (according to the Fulcrum “nowcasts”) had dipped to about 2 per cent, compared to a trend growth rate of 4 per cent. It was a bleak period. The dominant regime in financial markets was clearly one of rising risk of deflation.
Since then, however, there has been a marked rebound in global activity, and in recent weeks this has become surprisingly strong, at least by the modest standards seen hitherto in the post-shock economic recovery. According to the latest nowcasts, the growth rate in global activity is now estimated to be 4.4 per cent, compared to a low point of 2.2 per cent reached in March.
The latest growth estimate is the highest reported by the nowcast models since April, 2011 – before the euro crisis and the China slow-down hit global activity very hard. This relatively upbeat take on the current state is supported by alternative data sources. For example, the Goldman Sachs Global Leading Indicator has just reached its highest point since December, 2010.
The uptick in global activity growth has, of course, been accompanied by a rise in headline inflation rates in almost all major economies. Recently, I argued that this jump in inflation was still “weak and patchy”, and almost entirely due to the partial recovery in oil prices, which has been taken further this week by the market reaction to the OPEC decision to reduce oil production.
However, the bond markets have taken the reflation trade increasingly seriously, in part because of the assumed shift towards fiscal easing after the election of Donald Trump in the US. Although the case for a rise in core inflation in 2017 (as opposed to headline inflation) is far from convincing, the recent rebound in global activity may well give the “reflation trade” a further leg upwards.
Morgan Stanley says that investors have stopped asking “is reflation happening?” and instead they are now asking “will it prove sustainable?” It is easy to be sceptical about this. We could be observing nothing more than another short term spike in activity. But, for the moment, the newsflow is clearly improving in a manner that has not hitherto been seen during the faltering “recovery” from the Great Financial Crash. (Full details of the monthly nowcasts can be found here.) Read more