26th September 2011

Schroders: Global Economic Update

Are we heading for a double-dip recession?

Global growth has been very weak this year and the world economy has come very close to stalling. Our view though, is that we don’t get a double-dip. The reason the world economy has been so weak this year is that there have been some very strong headwinds to activity. Those headwinds are beginning to fade now as we go into the second half of the year and we think that means that activity will be stronger.

The headwinds that slowed things down at the beginning of the year were the Japanese earthquake, which disrupted supply chains and that caused a big problem, particularly in the auto industry but that’s now beginning to come to an end as Japan begins to recover. The second headwind has been the increase in energy prices. Oil prices in particular have risen very sharply, which has slowed down consumer spending growth. Oil prices are now stabilised and we can see inflation begin to come down a bit and that will help the consumer.

Aside from a pick up later this year what is needed to kick-start global growth?

It’s very difficult to see what can kick-start global growth at this time because monetary and fiscal policy really have gone as far as they can go. Interest rates have been cut as far as they can go so it’s possible that we get more quantitative easing, but our view is that won’t make a huge amount of difference. People are trying to deleverage and reduce their amount of borrowing, so they’re not really interested in taking advantage of low interest rates. 

Will future fiscal policy aid or hinder markets?

Fiscal policy options are also getting very limited. The one thing that could help the world economy at the moment would be a very sharp fall in commodity prices, but that doesn’t look likely in the near term. Fiscal policy is now beginning to tighten as governments are trying to bring their budget deficits under control, so from a growth perspective that’s not really going to be helping markets because spending will probably be a bit weaker as a result of that. Markets are also concerned about the level of government debt, so they do want to see some kind of plan in place for consolidation. Bond yields are very low and there is an opportunity for governments, that should they need to, could begin to loosen fiscal policy again and support growth, which would be favourable for markets.

Why has Greece’s bailout version 2.0 failed to reassure markets?

The second bailout package for Greece has failed to reassure the markets, first of all, because markets are not sure that the European countries are fully in support of that package. For example, some European countries have been asking for collateral in return for supporting Greece. In addition to that, there are doubts about the willingness and the ability of the Greek government to deliver the cuts they need to make in order to reassure the IMF. Markets have become quite doubtful about whether the second Greek bailout package is going to succeed. We’ve also seen contagion spread to Italy and Spain and so the problem has actually got worse.

Are we likely to see more intervention from the ECB?

The ECB are likely to continue to intervene in the European bond markets. The problem they face though is that by intervening and buying bonds, they reduce the incentive for the countries to reduce their budget deficits. The new incoming president of the ECB, Mario Draghi, has said that this is only a temporary measure and it’s no substitute for budget discipline. The problem the ECB face is that while they need to support bond markets, if they continue to do that, they won’t see the budget cuts that are needed to reduce deficits. It’s quite likely that we go through a period where the ECB pulls back in order to enforce more fiscal discipline before coming back into the markets, so this could again be another area of market uncertainty.

Where can investors find value right now?

Investors can find value in markets today by being tactical, looking for situations where the markets may have gone too far in one direction. For example, markets are already discounting quite a negative outlook for the world economy and that means that there’s a lot of value coming back into equity markets, particularly against government bonds. The other area that we need to look at is the imbalances in the world economy; there are a number of things that are probably unsustainable. The emerging markets, for example, continue to run big surpluses with the rest of the world and that suggests that their currencies will appreciate in the long run and that’s something that investors can take advantage of.

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