Is 2016 the year of doom and gloom?
The eurozone coping with a vacillating global economy: China, oil prices and inflation
After several months of relative calm, the global economy started the year with high volatility and poor market performance (Reuters), set off by weakness in the Chinese stock market and currency, the fall in oil prices and low inflation (New York Times). European stocks suffered the worst opening week of losses last week in more than four years.
In 2016, the Euro area will experience low growth and very low inflation. Analysts converge in their forecasts (for example Citi with growth slightly above 1.5% and inflation around 0.5%), with December data showing that core inflation is falling again (EuroIntelligence). Ashoka Mody (Bruegel) argues that the factors that dragged down the global economy in 2015 will persist – and in some cases even intensify – in 2016. The eurozone will be constrained by listless global trade. Goldman Sachs estimates the impact on European GDP of economic shocks to (1) the trade-weighted exchange rate, (2) oil prices, (3) short-term interest rates, (4) fiscal policy, (5) equity prices and (6) global growth—and finds that the net effect of the large recent changes to those variables is likely to be broadly neutral. Key downside risks are (i) a much more negative EM growth outlook and (ii) some unraveling of the EU framework. Daniel Gros (CEPS) writes that monetary union and Schengen will be put to the test but survive in 2016.
Worries and uncertainty about the Chinese economy. Fears of contagion from further China’s weakness are emerging, particularly for economies dependent on external demand, such as Germany (FT Alphaville).
Concerns about China's growth and currency are set to remain key drivers of global macro dynamics in 2016 (according to Citi)—with capital outflows, soft growth, and policymakers' focus on the effective exchange rate. China is expected to post its weakest quarterly economic growth for Q4 2015 since the global financial crisis with weak forecasts (Reuters). Fundamentals are sending mixed signals—Trade is falling (-1.4 percent yoy in December) but far less than expected (Wall Street Journal). Philippe Gijsels notes that RMB has very data-sensitive and not one-sided (towards depreciation) (UBS).
Alberto Gallo (RBS Silver Bullet) provides a detailed description of the latest market disruption, and also writes that policymakers have increasingly less policy room. Barclays Capital stresses that currency intervention, though the authorities confirmed there is no basis for continuous RMB depreciation, fuelled further risk aversion across the region, with Chinese equities triggering circuit breakers twice. Measures taken by the Chinese authorities include limiting the amount of stock large shareholders can sell.
A ‘hard landing’ in China is an important downside economic risk (Goldman Sachs): a sharp dislocation in China; an economic crisis in commodity producers suffering the fiscal consequences of lower commodity prices; or an emerging market financial crisis comparable to the events of the early 1980s in Latin America or late 1990s in Asia. EuroIntelligence concludes that a hard landing seems inevitable, given the massive internal imbalances that have built in the Chinese economy over a long period.
European growth has historically been tightly tied to world trade. With a slowing China and weaker global trade, low growth and inflation will likely continue in the euro area (Bruegel).
Weakness in emerging markets affects around 25% of Euro-Zone exports with the greatest effect on Germany, France, Italy and Spain (Economonitor). A China slowdown is likely to have an impact on the eurozone as its recovery rests on a devalued euro and a current account surplus of over 3%—with two important discussions: (i) whether China is experiencing a hard landing because it has failed to open markets—the WSJ reporting that China is dealing with the crisis with the old reflex of imposing de facto capital controls, and managing the exchange rate and (ii) a related discussion on the more limited impact of devaluations on economic growth (see the Economist)—especially as many countries try to solve crisis challenges through devaluation (EuroIntelligence).
Concerns about China may be overdone as argued by Tobias Ruhl (Unicredit), as illustrated by the latest hard data in the export-dependent German manufacturing sector. Furthermore, the renewed sharp drop in the oil price is huge tax-relief for companies and consumers. Erik Nielsen reinforces this point: growth is holding up pretty well, and financial markets are too small to affect the Chinese real economy, no matter how bad are the government’s financial policies. He is more concerned about the new global regime of de facto FX-targeting by many central banks, which – unannounced and uncoordinated – causes additional, damaging volatility and uncertainty in markets. And, as For SocGen's Andrew Lapthorne (hat-tip ZeroHedge) points out, what China reflects is a broader problem with lacking growth and the sudden market realization that fundamentals are lacking to justify current valuations.
Volatile and sharply lower oil prices. Oil dipped below $30 a barrel for the first time in 12 years (Bloomberg and New York Times)—directly linked to expectations about Chinese growth (Peter Pulikkan on Bloomberg) and weak recoveries in advanced economies.
Low oil prices, low inflation, and complicated monetary policy. The overall economic impact, especially for importers such as eurozone countries, is positive (Telegraph), but reinforces deflationary trends, as written by Ruben Segura-Cayuela (Bloomberg)—possibly requiring additional monetary policy actions, as hinted by the ECB (Reuters). Analysts are divided on the next policy move, some expecting no further easing (e.g., Neville Hill at Credit Suisse) and others forecasting more easing (Bloomberg). Paul Krugman says that low oil prices can be a significant drag on the world economy, especially in or near a liquidity trap (Krugman).
Unsettled European politics over refugees. Europe may be at the center stage of geopolitics in 2016 for Nouriel Roubini (Project Syndicate)—with Grexit, Brexit, and separatist movements, and the existential threat to Europe due to refugees. While Alison Smale and Andrew Higgins (NYT) note that the Spain’s election (see Alberto Gallo in RBS Silver Bullet) closes a difficult election year in Europe—which underscores Germany’s increasing isolation and Europe’s deepening division, Goldman Sachs writes that elections remain an important market driver, and reviews how economic conditions are likely to affect elections in 2016/17—with a premium for incumbents re-election.
The inflow of refugees has significant implications for the Euro area economic outlook in both the short and longer term, and for the potentially fragile political equilibrium both within and between European countries. The challenges include dealing with refugees already in Europe and containing additional refugees, even though the situation in the Middle East is unlikely to improve quickly—this is key to avoid a substantial political fall-out, as argued by Huw Pill at Goldman Sachs.
2015 has shown that European voters are deeply dissatisfied with mainstream parties European politics seem to be going toward more extreme positions. Far-right parties such as in Poland and in France are gaining political power, but also far-left parties in Greece, Spain and Portugal—proposing radical alternatives, and blaming the European project. Member states are increasingly adopting a national approach, thus undermining the possibility of Europe-wide solutions (the migration crisis is a tragic case in point). Guntram Wolff (Bruegel) insists that the EU must confront the populist challenge in 2016, i.e., traditional parties must give informed answers to the problems identified by populists. European institutions may have a harder time proposing and acting toward greater integration, at a moment when the construction of a transnational democracy is the most viable response to political polarization in Europe, according to Jean Pisani-Ferry (Project Syndicate). Martin Feldstein (Project Syndicate) notes that risks to the Euro area forecast stem largely from the political domain, including: the refugee crisis (undermining Merkel); a Greek derailment; ‘Brexit’, and Spanish political uncertainties around Catalan independence.
The Short View… The European Commission has triggered rule-of-law monitoring of Poland, in an unprecedented step, prompted by constitutional and media reforms (EU Observer). This would be the first step toward possible sanctions of Warsaw for actions that may violate the Union’s democratic principles (Politico).
