In mid 2016, the global economy embarked on a regime of reflation that has been dominating market behaviour ever since then. This has constituted a simultaneous rise in real output growth, along with a rebound in inflation as commodity prices have recovered from their 2014-15 slump.

The result has been a sharp increase in nominal GDP growth in most of the major economies. As the secular stagnation theme has lost its potency for investors, a decline in the perceived risk of outright deflation has triggered a rise in breakeven inflation expectations in bond markets everywhere.

One of the most important questions for 2017 is whether this bout of reflation will continue. My answer, based partly on the latest results from the Fulcrum nowcast and inflation models (see first graph), is that it will continue, at least compared to the sluggish rates of increase in nominal GDP since the Great Financial Crash.

However, the nature of the reflation theme is changing. The term “reflation” does not necessarily imply that global inflation, or inflation expectations, will continue to rise very much from here.

A likely pattern in 2017 is that there will be upgrades in consensus forecasts for real output growth, but inflation will stabilise, and will not threaten to break above central bank targets in most advanced economies.

Equities and other risk assets would probably view this as a healthy mix of output and inflation components of national income, while bond markets would probably exhibit a stabilisation in breakeven inflation expectations, with real yields rising a bit. Read more

According to the latest results from Fulcrum’s “nowcast models”, the global economy has continued to perform adequately in July, despite considerable doubts in the financial markets about a possible hard landing in the Chinese economy, and rising concerns about weakness in the emerging world, especially in commodity-driven, and smaller Asian, economies.

The latest growth rate in global activity is estimated to be 3.2 per cent (PPP weighted), which is roughly the same as last month’s estimate.

The advanced economies are estimated to be expanding at an annualised rate of 1.7 per cent, which is very close to trend. Meanwhile, the major emerging economies are growing at a rate of 4.6 per cent, which is about one percentage point below trend, but better than recorded a few months ago.

The gap of 2.9 percentage points between the growth rate in the emerging and advanced economies is far smaller than the 3.8 percentage point gap in the estimated long term growth rates in the two blocs, reflecting the continuing cyclical downswing in most emerging economies.

The continuing weak state of the emerging bloc remains a major headache for the world economy and global financial markets, though the risk of a global hard landing does seem to have diminished since the first quarter.

The main conundrum this month concerns the growth rate in China. On our models, which are based on a mix of official economic data and other series (like electricity and cement production, car sales, freight traffic and trade flows through harbors), China is growing at close to its 7 per cent trend. But other factors, like the weakness of commodities and of industrial production in the rest of emerging Asia, seems consistent with much weaker growth in China.

Many observers are very sceptical about the accuracy of Chinese data, especially during downturns, but an alternative explanation is that Chinese growth has recently been more concentrated in service sectors, which have lower commodity useage than manufacturing and real estate sectors. In the absence of any obviously superior sources of data, official or unofficial, our activity models are driven by the latter view. Read more

When the Federal Open Market Committee meets on March 17-18, it will be able to drop the word “patient” from its statement without shocking the markets. After some confusion, the Fed’s intentions on the date of lift off now seem fairly priced, with Fed funds rate contracts showing a probability of more than 50 per cent that the first move will come in June. The behaviour of the dollar, and of core inflation, are likely to determine whether June or September is eventually chosen for lift off.

Once that is out of the way, the markets will turn their attention to a much harder question: how rapidly will rates rise after lift off? The market currently expects a much more gradual path than the median shown in the FOMC’s “dot” chart, but there is huge uncertainty about this question on the committee. As the graph above shows, the interest rate forecasts for individual members of the FOMC, which will be updated on Wednesday, have a very wide range.

According to Fed vice-chairman Stanley Fischer, the rationale for rate rises is that the Fed wants to embark on a process of “normalisation”, and he is adamant that today’s rates are “far from normal”. That, of course, raises the question: how should we define normal? On this, the leadership group on the FOMC is not offering much guidance, but a common way of answering the question among macro economists is to consult the Taylor rule. Read more

The work of Carmen Reinhart and Ken Rogoff (RR) on public sector debt ratios, and their relationship with GDP growth, has been extraordinarily influential in academic and policy circles since 2010. Before this week, their statistical analysis, based on a 200-year database which they had painstakingly assembled covering dozens of countries, had appeared to establish an important stylised fact: that debt ratios above 90 per cent were associated with much lower rates of GDP growth than debt ratios under 90 per cent. The sudden drop in growth at a debt ratio similar to that reached in many developed economies acted as a wake up call to governments and encouraged the adoption of austerity programmes.

This week, a paper by Thomas Herndon, Michael Ash and Robert Pollin (HAP) argued that the RR stylised fact was based on simple statistical errors, including a spreadsheet error which RR have now acknowledged. Their critique of the original RR stylised fact promises to establish an alternative conventional wisdom, which is that high public debt ratios are never damaging for GDP growth. But the truth is more complicated than that, and far less certain. Read more

The transfer of power in China from the outgoing regime led by Hu Jintao to the incoming leadership of Xi Jinping has occurred without a hitch. This is a mark of increased political maturity in China.

In fact, the handover has been described by Citigroup economists as the first complete and orderly transition of power in the 91-year history of the Chinese Communist party.

During President Hu’s decade, China’s real GDP per capita rose at 9.9 per cent per annum. China accounted for 24 per cent of the entire growth in the global economy, and Chinese annual consumption of many basic commodities now stands at about half of the world total. Perhaps the most important question in the world economy today is whether China’s economic miracle can continue in the decade of Xi Jinping. The IMF forecasts shown in the graph above suggest that the miracle will persist, but many western economists disagree. Read more

©J. McHugh

The UK coalition government has reached almost exactly the halfway point in its electoral term. Quite soon, it will be too late for it to change its economic approach in time for the results to be seen before it goes to the polls on May 7 2015. Whether the prime minister recognises it or not, he is therefore facing a major strategic choice. Should the government change tack, while there is still time?

The strategy chosen by chancellor George Osborne in 2010 was based on a more rapid tightening in budgetary policy than was adopted in most other developed economies. The chancellor knew that the Bank of England would aggressively ease monetary policy in support of his plan, and hoped that this would result in a sharp depreciation of the real exchange rate, though he did not say this in public.

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The annual meetings of the IMF and the World Bank take place in Tokyo this week, and as always they provide a good opportunity to take stock of the condition of the global economy, and of economic policy.

There is much less of a crisis atmosphere surrounding this week’s meetings than there was a year ago, largely because the actions of the ECB have succeeded in calming the eurozone storm for the time being.

However, there have been significant downgrades to growth prospects in China and India in the past year, and growth in the major developed economies has been extremely unsatisfactory. Read more

Risk assets rose slightly last week, and global equities are still trading within about 2 per cent of their highs for the year. The resilience of equities was slightly surprising in a week which saw both a disappointing set of US GDP data and a Fed policy statement which was on the hawkish side of expectations. Goldman Sachs’ economists commented that the US economy and financial markets are “moving into a tougher environment”, in which the economy is slowing and the Fed is shifting its policy reaction function in a less stimulative direction.

One reason why risk assets have remained firm recently, is that earnings in the latest company reporting season have once again been beating expectations in the US and the eurozone. According to Jan Loeys at JP Morgan, US corporate earnings per share for 2012 Q1 have come in 8 per cent higher than analysts’ expectations, while the drop in eurozone earnings has been 4 per cent less than feared. Clearly, corporate financial strength has been helping investment sentiment, but that would not persist for very long if the Fed really did change its tune on monetary policy. Read more