Wednesday, January 5, 2011

Macro themes for 2011

For those of you who either haven’t read the December issue of QSO, or have read it but forgotten it already, here’s a summary of the key macro themes for 2011:

1) After posting what looks like 4.5%+ growth in 2010, we expect global growth of 4% in 2011. This will, again, be driven by strong growth in emerging markets while the key developed markets will continue to struggle under the weight of continued household deleveraging and weak job growth (US) and fiscal belt-tightening (Europe). Growth then builds again in 2012, making 2011, not a double-dip, but definitely a post-dip-blip.

2) Growth in the US will remain subdued thanks to the headwinds of continued deleveraging at the household level, soft jobs growth and a housing market that is still struggling to form a base. Having said all that we have raised our 2011 US GDP forecast from 2.5% to 3.0% on the back of cuts to payroll taxes, stronger business investment and exports. This is however, still not robust growth for this stage of a recovery. Consumption won’t gain any robust traction until households are more comfortable with their balance sheets, which could be still 2-3 years away.

3) Structural issues will remain a key focus for Europe. Sovereign debt will continue to be the catalyst for further concern in this region. More precisely, government financing requirements of around 20% of GDP in 2011 will be the immediate challenge. This is not as high as the funding requirements of other governments, but Europe is a different case. For example Japan, with a funding requirement of 58% of GDP, runs a current account surplus and has significant foreign assets, making them less reliant on global capital markets. The US, with a funding requirement of 25% of GDP, runs a current account deficit making them reliant on foreign capital. However, the status of the USD as a preferred reserve currency means there will continue to be strong demand for their public securities. There is considerable economic diversity across Europe, with questionable commitment to improved governance across the region. With that comes concern about the degree of commitment to the survival of the Euro. It will be another challenging year for Europe. At the very least, we expect to see another “shock and awe” strategy play out (Shock and Awe II?) as the European Financial Stability Facility is beefed up.

4) Inflation will be the primary concern in emerging markets in 2011. This will further highlight the difference in economic challenges between developed and emerging economies. For developed markets the challenge will be weak growth and inflation that is too low, while in emerging markets, the challenge will be over heating and rising inflation. This will be most evident in China. China raised benchmark interest rates on Christmas Day, and we expect to see further increases in 2011. A stronger Yuan and further increases in the required reserve ratio can also be expected. We fully support actions to keep inflation in check. Going right back to the start of the recovery, we warned that the biggest risk to rising prosperity in emerging markets was any lack of commitment on the part of authorities to tackle inflation. We would rather see lower stable growth than boom and bust cycles.

5) Economic growth in New Zealand undershot even our miserly growth forecasts in the second half of 2010. The recovery will build some momentum in 2011, but this will be partly due to temporary factors such as the Canterbury earthquake rebuild and the Rugby World Cup. Without those, the NZ economy would likely do no better than about 2% growth. However, with potential growth now lower, inflation will become a problem earlier in the cycle, but that’s not something to worry too much about in the first half of the year. When the time comes for withdrawal of the stimulus, the interplay between monetary and fiscal policy will be….let’s call it “interesting”.