There is good news and not-so-good news as we head into 2016.
The not-so-good news is that the world economy still lacks momentum, with global growth unlikely to pick up next year. We expect growth of 3 per cent, the same as 2015. But the good news is that, despite the lack of momentum in the world economy, we expect confidence and market sentiment, particularly in emerging markets, to improve.
Emerging markets have been in retreat in 2015, but there are reasons to be cautiously optimistic in 2016. The two main reasons behind the negativity this year – the US Federal Reserve (Fed) interest rate hikes and the risk of a ‘hard landing’ in China’s economy – should be much less of a concern in 2016. It is time to regroup.
Expect short-lived rate hikes
We always thought the first Fed rate hike in nine-and-a-half years would be an event. We highlighted as far back as April 2015 that volatility in emerging markets would increase and that some currencies, like the Turkish lira, the Indonesian rupiah and the Brazilian real, would weaken. So the weakness and negativity we saw in the second half of 2015 did not come as a surprise.
But there are two main differences today. First, markets have already moved in anticipation. To a great extent, the Fed hikes are already reflected in prices. Second, we think that the Fed’s hiking cycle will be both very shallow and short lived.
The US economy has already peaked
We expect the first interest rate hike to take place in December 2015, with another hike in March 2016. And that is it; we do not expect more rate rises in 2016. In fact, we anticipate that after March the Fed’s next move will be to reduce interest rates, and we see this happening in December 2016.
We believe the hiking cycle will be shallow because, in our view, the US economy has already peaked. Consensus forecasts point to US growth at 2.5 per cent next year, but these forecasts have been consistently wrong over the past six years, always overestimating growth prospects in the US. We are less optimistic, expecting the US economy to grow by 1.6 per cent. If the anticipation of Fed hikes spooked markets in 2015, and rightly so, the realisation that the hiking cycle will likely be very shallow by any historical standard should be positive for market sentiment.
China is changing
China concerns also played a key role in keeping sentiment around emerging markets negative. Markets have behaved in a way consistent with a China ‘hard landing’. In 2015, closer focus on certain proxies for China’s economy suggested that growth was much slower than official data implied, hence the negativity.
But concerns were overdone and not fully justified. The proxies used by many were heavily biased towards the manufacturing sector. Manufacturing in China is indeed slowing; but the service sector is strong, and it is growing in importance, contributing more than 50 per cent to the economy today. Looking at cement, electricity and railway cargo might have been a good proxy for growth 5-10 years ago, when manufacturing dominated, but this is no longer the case. The structure of China’s economy is changing.
We expect Chinese growth in 2016 to be 6.8 per cent, giving the authorities room for possible deceleration in the future
Also, people should not underestimate the commitment of Chinese authorities to deliver growth rates close to 7 per cent. Policy makers take every opportunity to remind us that they have an official target of doubling 2010 GDP by 2020. This requires an average annual growth rate of 7 per cent. So far they are ahead of plan, and the Fifth Plenum – the government’s planning forum, which took place this autumn – set an average growth target of 6.5 per cent for the next five years. We expect Chinese growth in 2016 to be 6.8 per cent, giving the authorities room for possible deceleration in the future.
That is not to say that there are no risks. China’s economy is becoming more complex. Gradually opening up to international markets by liberalising the capital account will make the economy harder to manage than in the past, especially given high domestic debt levels. But policy makers have tools at their disposal.
Global growth has never really taken off since the global financial crisis. 2016 is unlikely to be any different
Interest rates have been cut several times, the reserve requirement ratio has been reduced, and domestic money supply is now growing at 13 per cent. This is adequate and will be supportive of growth. Monetary policy can now turn neutral and wait for the positive impact on the economy, which usually works with a lag of 6-12 months.
Global growth has never really taken off since the global financial crisis. As 2016 is unlikely to be any different, it is hard to get too excited about the economic prospects. The silver lining is that confidence and market sentiment should improve.