Before Friday’s relief rally, the recent severe market turbulence had three distinct phases. It started with concerns about Chinese exchange rate policy. Then came a renewed collapse in oil prices. Finally, last week, came increased fears of a persistent slow-down in the US economy, following weak activity data from the US industrial sector.

The last of these factors is perhaps the most serious for the markets, since it represents the first genuine reason to worry that an important part of the global economy might actually be weakening. Until now, the bear phase in equity markets has not been backed by much evidence of a slow-down in global activity, though our “nowcasts” have been warning for some time that US growth has been out of line with the global aggregate, and is heading in the wrong direction.

The markets have tended to agree with the Federal Reserve in viewing this as a temporary dip, driven largely by specific drags on the US manufacturing sector. But now investors are starting to worry that the slow-down could become much more persistent than previously believed. The drags from oil output, foreign demand and the rising dollar are proving to be more negative for the economy than forecasters, including the Fed, have recognised. Read more

The 9 percent drop in global equity prices in the first two weeks of 2016 is certainly alarming, even for those of us who believe that the outlook for the world activity has not deteriorated much recently. The fundamental cause is the same as it was last August – a clash between a severe loss of credibility in Chinese economic policy and a Federal Reserve that still seems determined to continue tightening US monetary policy without much regard to international risks and a slowing domestic economy (see the hawkish Bill Dudley speech on Friday). Oil prices are also playing a part, but only a bit part, in my view.

The key question is whether China can restore confidence in its exchange rate policy, not least among its own citizens. For as long as a renminbi devaluation of unknown size continues to overhang the markets, an abatement in capital outflows, and a return to stability, seems difficult.

It is even possible that the event that markets most fear – a controlled depreciation of 10 per cent or so – might be the only way of restoring calm, if accompanied by other reforms. Until the renminbi is deemed by the global financial system to be at a sustainable level, fear of disruptive change will dominate sentiment. Read more

The first week of market trading in the new year has seen alarming declines in risk assets – the largest early January falls since records began in some markets. This outbreak of bearishness has no doubt been driven by further falls in oil prices and the weakness of the renminbi, both of which could lead to major financial dislocations across the world. But a really large bear market in global equities and credit is unlikely to take hold unless and until there is a major weakening in global economic activity.

So far, our regular monthly “nowcasts” of economic activity, which are updated in full here, have not picked up any decline in global growth, compared to the average recorded in recent quarters.

The overall growth rate in global activity is now running at roughly 3 per cent, which is actually slightly higher than than the growth rate recorded in 2015 Q3, the date of the previous global market scare. This conclusion is strengthened by the latest industrial production data, which show that the global IP growth rate has rebounded to about 2 per cent, compared to -2 per cent about a year ago.

The results for individual countries this month do not support widespread fears of a hard landing in China, but (surprisingly) they do identify a progressive slowdown in the US. This would become worrying for markets if it persisted into 2016 Q1, especially if it continued to be ignored by the Federal Reserve.

European growth remains robust (by its own tepid standards). In fact, the large gap in activity growth between the eurozone and the US is unusual, and is counter to the recent changes in monetary policy in the two blocs. This growth pattern needs to change in coming months if the Fed/ECB “divergence” in monetary policy is to take its expected course this year. Read more

The risk of a large devaluation in the Chinese renminbi is once again spooking markets, which are firmly convinced that this as a very bad contingency for global risk assets in 2016. As last year ended, investors became more relaxed about the threat, following a series of veiled announcements from the PBoC about its currency strategy. These statements seemed to suggest that the central bank would broadly stabilise the effective exchange rate against a currency basket from now on, while allowing greater flexibility against a (possibly) rising dollar.

Since the dawn of the new year, however, investors have become much more concerned that a larger devaluation may be in the works, either through the choice of the Chinese authorities, or because the outflow of private capital is getting out of hand. Some bears in the currency markets believe that China could soon be suffering from a genuine exchange rate crisis, in which its enormous foreign exchange reserves could be quickly drained.

That would indeed be a severe shock to global markets, since it would effectively export the deflationary forces that are overpowering the Chinese manufacturing sector to the rest of the world, and would probably require direct measures to restore the health of the Chinese financial system. But it still seems unlikely to happen, for now at least. Read more

Most investors have been able to muster only two cheers for the year that has just ended.

In 2015, the performance of the main asset classes just about managed to maintain the broad pattern that has been seen since the equity bull market started in March 2009 but there are now definite signs of market fatigue. And although some major trends were obvious in retrospect — weak oil prices, falling euro, rising dollar, tumbling emerging currencies – they recorded sharp reversals that many macro investors failed to navigate in real time.

Global equities returned about 2 per cent in local currency terms [1], less than in recent years. In dollar terms, returns were slightly negative and market peaks in May 2015 have not yet been re-attained. A top may be forming, but as yet there is little sign that a major bear market trend has started.

Government bonds returned about 1 per cent, defying widespread predictions of a trend reversal, and yields were almost exactly flat during the year. Commodity prices plummeted by 33 per cent, continuing the crash that started in mid 2014, and they eventually took credit markets down with them. US high yield securities, for example, returned -9 per cent in 2015. Emerging markets (with the perplexing exception of Chinese equities, the best performing of the major markets) were also hit by the commodity melt-down and generally continued to under-perform developed market assets, in equities, credit and currencies.

Overall, then, the magic mix of moderate gross domestic product growth combined with extremely easy monetary conditions has continued to work in the developed markets. However, overall global asset market returns (bonds plus equities in local currencies, equally weighted) were only about 1.5 per cent, suggesting that some of the magic is wearing thin.

Looking ahead, it seems likely that 2016 will, at best, see similarly low asset returns. That, anyway, is overwhelmingly the consensus central view among mainstream forecasters. But as the bull market matures, it seems inevitable that one year soon we will experience a major setback to asset prices. Will 2016 be that year? Read more

It would be tempting to ascribe the large drop in global risk assets last week to the onset of Federal Reserve tightening and a further meltdown in commodity prices. No doubt these factors played a part, but the dominant force was probably the same one that shook the markets in August – the fear of a sudden devaluation of the Chinese renminbi. This would export deflationary forces from China’s industrial sector to the rest of the world, and would interact very badly with the start of a monetary tightening cycle in the US. Read more

As one day shocks go, the market reaction to the ECB’s announcements on Thursday was very dramatic. The 4.5 per cent intraday reversal in the dollar/euro exchange rate was the largest since 2009, and the combined drop in equities, bonds and the dollar has been described as the most severe since 1999.

Mr Draghi must have been concerned about this extreme market reaction, because his speech in New York the following day struck an entirely different tone. He attempted to upgrade the size of the new package of quantitative easing from €360 billion to €680 billion, and in effect promised unlimited QE until the inflation objective is reached (see John Authers).

Many investors have blamed Mr Draghi for some misleading forward guidance going into the Governing Council meeting. The announcement certainly fell some distance short of the pre-emptive easing that appeared to be in his mind less than one month ago, when he said that the ECB would use “all instruments” to return inflation to target “without undue delay”. Almost all professional ECB watchers were wrong-footed by the turn of events at the end of last week.

So which is the real Mr Draghi? And is he still in control? Read more

This is the latest report in our regular monthly series of “nowcasts” for global activity.

Global economic data published in November have shown a further uptick in worldwide activity growth after the significant dip that was reported after mid-year.

It now appears almost certain that the 2015 Q3 dip in world activity was not the precursor of a slide towards global recession. Instead, it seems to have been another of the minor mid-course corrections that have been a consistent feature of the moderate upswing in global activity that started in 2009.

Although the recent flow of data has therefore been somewhat reassuring about the global cycle, serious problems are still prevalent in the world economy. China has not suffered a hard landing; but severe deflation in the manufacturing sector remains unchecked, and the economy is clearly slowing as rebalancing between old and new sectors takes effect.

Most other emerging economies are now embarking on a major deleveraging cycle, and this may drag on EM growth rates for several more years. Growth in the advanced economies as a whole has been stable at about trend rates throughout 2015; but underlying productivity growth remains extremely weak by past standards. Therefore the advanced economies do not appear sufficiently robust to withstand an intensification of the EM shock, should that occur.

Overall, the global economy continues to grow below trend rates, so at some deep level the deflationary pressures in the system are not abating. However, the specific deflationary impetus from the commodity price collapse is now passing its maximum effect so recorded rates of headline and core inflation are likely to rise significantly in the next few months.

The latest data therefore confirm the conclusion reached in last month’s report: the global economy is suffering from a longstanding malaise but not from a cyclical recession. Full details of this month’s nowcasts and global industrial production data are attached hereRead more

Financial markets have been adjusting to the high likelihood of another aggressive round of unconventional monetary easing by the ECB on 3 December. This will complete a remarkable metamorphosis by a central bank that has traditionally been viewed as the most conservative in the developed economies, with the possible exception of the Swiss National Bank.

Mario Draghi’s official case for extra monetary easing is straightforward. Although the Eurozone economy has performed broadly as expected in recent months, the Governing Council has decided that “downside risks” to growth and inflation have increased, largely due to events in China. As a result, it may take longer to restore inflation to the target of “close to” 2 percent, and there is a greater danger of inflation expectations breaking lower in the meantime.

This may make sense, but there is little hard evidence that these risks are actually becoming reality. Activity growth in the Eurozone has recently increased to over 2 per cent, and core inflation is rising slightly. If the situation is bad today, it was even worse a few months ago. Read more

The new Chief Economist at the IMF, Maurice Obstfeld, posed a challenging question at the end of his first major policy conference in charge last week: “Is China the new Japan?” This question has been asked before, usually in the context of the massive credit bubbles in the two economies. The deflationary lessons from Japan’s imploding bubble in the 1990s are often thought to be relevant to China’s credit bubble in the 2010s, and this story is far from over.

Maurice Obstfeld, however, had something more specific in mind. He cited the work of the late Ronald McKinnon, a distinguished international economist who argued in the 1990s that Japan was being forced into deflation by an overvalued exchange rate. That, in turn, stemmed from the political pressure exerted on Japan to correct its current account surplus by raising the value of the yen. The implied threat, notably (but not solely) from the US Congress, was that direct trade controls would be imposed on Japanese exports if the exchange rate were “artificially” held down. Read more

The latest and, so far, the most severe scare about global deflation started with the oil price collapse in mid 2014, and reached its peak with the sharp drop in global industrial production in mid 2015, swiftly followed by the Chinese devaluation episode in August. Fears of an imminent slide towards a global industrial recession haunted the markets, and both expected inflation and bond yields in the advanced economies approached all-time lows.

But, just when everything seemed so bleak, the flow of economic information changed direction. Global industrial production rallied, and China stabilised its currency. On Friday, the US jobs and wages data were much stronger than expected. Inflation data in the advanced economies have passed their low points for this cycle, and the rise in headline 12-month inflation in the next three months could surprise the markets.

This certainly does not mean that the repeated warnings of the inflationistas will suddenly be proved right. It may not even mean that long-run deflationary pressures in the global economy have been fully overcome: global growth rates are still below trend, and spare capacity is rising in the emerging world. But the peak of the latest, commodity-induced deflation scare is in the past. Read more

In this month’s regular report card on global activity growth rates, we conclude that the downward momentum identified by our “nowcasts” a month ago seems to have been arrested during October. The risk of a global recession has therefore declined recently, but growth in the emerging markets remains well below trend, and global spare capacity is continuing to rise.

Furthermore, the growth rate in activity in the US has dropped since mid year, and is now slightly below trend. Other advanced economies, especially the euro area, continue to record reasonably healthy, above trend growth rates, with some signs of a recent acceleration.

Overall, we therefore conclude that the risk of a global hard landing has diminished in the past month. However, while not in recession, the global economy does appear to be in the midst of a growth malaise, in which the “miracle” of the 2000s in the emerging world is unraveling, and productivity growth in the advanced economies has maintained its long term downtrend.

In this month’s report, we will examine the main sources of the global growth malaise in more detail. (Full results of all the latest global nowcasts are attached here. Last month’s report card, with explanations of the regular graphical layout, is attached here.) Read more

Mario Draghi surprised markets last week with an aggressively easy policy statement, even by his recent standards. No longer shackled, it seems, by the restraining force of the Bundesbank, the European Central Bank Governing Council became the first of the major central banks to react forcibly to the severe downturn now underway in many of the emerging markets. With the US Federal Reserve still expected to raise interest rates in December, the “divergence trade” in the foreign exchange markets (ie long dollar, short euro and yen) seems back in vogue.

This trade has worked well at times in the past 12 months, mainly because of the unexpectedly large programme of quantitative easing by the ECB. Up to now, the Federal Reserve has contributed very little to the policy divergence, essentially doing nothing since tapering ended a year ago this week. This would change markedly if the Fed now implements its “expectation” to tighten monetary policy in December. Read more

Janet Yellen

Janet Yellen, Fed chair  © Getty Images

This week has seen speculation about a mutiny from two members of the Federal Reserve’s board of governors against the leadership of Janet Yellen and Stanley Fischer, both of whom continue to say that they “expect” US rates to rise before the end of the year. Although “mutiny” is a strong term to describe differences of opinion in the contemplative corridors of the Fed, there is little doubt that the institution is now seriously split on the direction of monetary policy.

Furthermore, these splits could extend well beyond the date of the first rate hike to the entire path for rates in the next few years. Ms Yellen faces an unenviable task in finding a compromise path that both sides of the Federal Open Market Committee can support. Read more

After several years of moderate but sustained worldwide GDP growth, the spectre of a global recession in 2016 can no longer be completely discounted. Brazil and Russia are already suffering from eviscerating economic down-turns and the growth rates of many other emerging economies, including China, have subsided to well below trend. Although the advanced economies are still growing roughly at trend, the world economy in aggregate is now slowing and the IMF is among many to warn about a sharp increase in downside risks.

The good news is that global recessions are very rare. On the IMF’s preferred definition (ie negative growth in global GDP per capita – the blue line in the graph), there have only been four such events in the entire post war period, in 1975, 1982, 1991 and 2009. The bad news, though, is that when they do occur, they are catastrophic for financial markets and unemployment.

As Lawrence Summers has pointed out, economists are not good at predicting recessions a year in advance. Famously, Paul Samuelson said the stock market had predicted “nine of the last five recessions”. Economists, on the other hand, have predicted none of them. Recessions happen suddenly, sometimes out of a clear blue sky, and forecasters hardly ever build a severe recession into a “main case” forecast more than a quarter or two in advance. Read more

In the aftermath of the supposedly “weak” US employment data published last week, investors seem to have shifted their assessment of the likelihood of the US Federal Reserve tightening interest rates by December — and also of the extent of tightening in the next two years.

Since the data were published, several investment banks’ economics teams have ruled out a December rise. Furthermore, equities have been strong; and the bond market’s implied probability of a 25 basis points rise in the federal funds rate by December has fallen from 76 per cent in mid-September to only about 40 per cent.

Nor is this seen as a minor postponement in the first rate rise. The expected federal funds rate at the end of 2016 implies only two Fed rate hikes in total over that entire period. Clearly, investors increasingly believe that the US economy is now slowing enough to throw the Fed off course.

This big change in market opinion is, frankly, surprising. The rise of 142,000 in non-farm payrolls in September was not all that weak, given the normal random fluctuations in the monthly data. And as John Williams, president of the San Francisco Fed, has pointed out, a slowdown to a monthly rate of increase of under 200,000 was long overdue anyway. Rightly or wrongly, there is little indication so far that important Federal Open Market Committee members share the market’s increased post-jobs-data dovishness.

The crucial question is how much growth in the US has slowed since the middle of the year, and whether this will continue. This is the kind of question that economic “nowcasts” are best suited to answer, so let us examine the recent evidence. Read more


The turbulence in the global financial markets in the past few weeks has been widely attributed to a “China shock” that has increased the risks of a major downturn in global activity. Last month, this blog concluded that our regular “nowcasts” for global activity had not yet corroborated this narrative.

This month, we have identified the first clear evidence that the global economy has slowed down since mid year, with emerging markets and advanced economies both now growing more slowly. A new factor is a clear slowdown in the US economy, though much of this appears to be due to the temporary effects of an inventory shake-out.

The Chinese economy has not shown any further signs of slowdown in September. The dominant contractionary force in the global economy is a commodity shock, which of course is somewhat connected to events in China (as it rebalances its economy away from commodity-consuming sectors), but it is not exactly the same thing.

The commodity shock is redistributing activity away from commodity producers and towards commodity consumers, both within and between countries. Eventually, the commodity shock should be net beneficial to the global economy, but so far global activity growth has dropped to only 2.6 per cent, which is 0.4 per cent below the rate in mid year, and 0.8 percentage points below trend. This means that global spare capacity is currently rising at a worrying rate.

Because the emerging markets are much more exposed to commodity producers than developed markets, they have been hard hit by the commodity shock. They are now growing at 3.5 per cent, or 1.5 percentage points below trend. It is unclear whether this growth rate is still dropping.

In the advanced economies, the growth rate in activity is about 1.7 per cent, which is roughly at trend. The slowdown identified in the US in September has been offset to some extent by signs of firmer activity in the eurozone.

An important and worrying feature of global growth in 2015 has been the large drop in global industrial production relative to services in the second quarter. This was driven mainly by weakness in industrial production in the US energy sector – not in China – and it has since been reversed. Read more

In her latest speech last Thursday, Janet Yellen left no further room for doubt that the vast majority of the Federal Open Market Committee supports a rate hike this year, and that she personally shares this view. They are confident that a firm recovery has now taken hold in the US. But the markets are nervous about this, believing that the emerging market shock is gathering momentum and that it could bring the developed economies down with it. What would happen if the Fed is making a historic mistake?

That was the question posed, implicitly, by the Bank of England’s Chief Economist Andrew Haldane in one of his challenging speeches on 18 September. As he points out, it is quite likely that the next recession in the developed world will arrive with interest rates still stuck close to the zero lower bound. What then? Read more

When Janet Yellen announced last week that the Federal Open Market Committee had considered, but decided against, a rate rise in September, many commentators concluded that the Fed had taken a decisive shift towards dovishness. Yet the markets, so far, have not really shared this interpretation. Since Thursday’s press conference by the chair of the US Federal Reserve, the interest rate path expected by the bond markets has dropped very slightly; but the dollar has risen and equities have remained weak.

There is little sign that investors’ assessment of the Fed’s underlying policy stance has been altered by what is increasingly seen as nothing more than a “postponement” of the almost inevitable rate hike later this year. Whatever it intended to do, the Fed has not cleared the air. Read more

After increasing relentlessly for two decades, China’s foreign exchange reserves started to decline about a year ago, and during the crisis month of August 2015 they plummeted alarmingly. Seen by many investors as a signal of waning confidence in the credibility of Chinese economic policy, a collapse in the reserves is now taken as one of the prime reasons to dump risk assets on a global basis. As the balance sheet of the PBOC shrinks, investors fear that “quantitative tightening” will be triggered in developed bond markets, and worry that a credit crunch will occur in China itself.

These concerns are not entirely without foundation but a confidence run on the renminbi is still unlikely. Much will depend on whether the Chinese authorities can shed their cloak of secrecy sufficiently to lay out a clear strategy for the reserves, the exchange rate, monetary policy and the necessary clean up in the domestic banking system. If the right strategy emerges, confidence can be restored, because China is very far from being an insolvent nation. Read more