Where does Q1 slowdown leave the growth story?

In Belfast last week, we discussed with trustees that the first quarter of this year was supposed to have been the period in which the ‘global economic recovery’ became entrenched and instead, data show that both US and French GDP have stagnated, Germany’s economy expanded but Italy’s did not; Japan produced some growth ahead of its ‘fiscal cliff’ but China’s economy slowed appreciably.

Unsurprisingly in this environment, world trade trends, which had picked up slightly over the fourth quarter of last year on the back of seemingly better Euroland and Chinese trends, seem to have weakened once again and world trade price trends have deteriorated as more and more countries and regions have attempted to simultaneously improve their current account balances. These disappointing global trends of course also confirm the generally weak message offered by the latest crop of GDP releases.

In terms of why economies slowed, the relatively strange global weather patterns that have been experienced so far this year will have exerted some impact on individual countries’ growth trends. Thus cold weather in the Northeast and a drought in the West seem to have subdued US trends to some extent, and warm weather in Europe evidently boosted German construction and investment – but reduced activity in the gas-producing Dutch economy. However whilst we have a ‘pro-growth’ stance on balance we need to be alive to the risks of disappointment and it may be that changing weather patterns affected parts of the global economy in different ways but averaged out their effects were about neutral for the world as a whole. An alternative and plausible thesis for the relatively subdued growth environment in the first quarter would be the effects of the still extremely weak household real income trends around the world and the challenge that unlike the situation that prevailed during much of the similarly income-constrained Noughties, households have not been able to circumvent the income constraint on their spending by using more credit or by withdrawing equity from their homes. These may represent fundamental constraints on the ability of the global economy to grow.

As to why we are optimistic, we are reading the lead indicators but we and the lead indicators may be biased by recognized behavioural factors. Thus after a prolonged downturn, most people want to believe that global economic recovery is underway. People first become inured to ongoing economic risk and then became simply tired of weak growth stories. Instead they actively looked for good news on growth if only to break the monotony. More tactically and perhaps practically, parts of the sell side may feel unable to revise down forecasts following all the effort that they put into telling the growth re-bound story at the turn of the year.

To gauge the likely way forward, and to determine whether we are likely right in having an optimistic perspective of the outlook, we will monitor the actions of central banks, who arguably have the best sight line of the data and trends and there is a disconnect between some of the statements made and actions taken. For example, the Federal Reserve has talked of tapering their Quantitative Easing but during April, the Federal Reserve’s five week rolling bond purchase totals averaged around $61bn. Certainly this was lower than March’s $70bn monthly average, but still represented a massive $750bn annualised rate of implied debt monetisation.

Whilst the US Fed has remained supportive in practice, the Bank of Japan (BoJ) has been slowing its rate of net acquisitions of Japanese Government Bonds (JGBs). This may be because of the impact that Yen weakness has exerted on household real income trends and the nominal current account balance, or the amount of ‘JGB risk’ that the BoJ has been obliged to acquire under Abe-nomics in return for seemingly little or no structural reform from the government. Whatever the exact reasoning, the BoJ seems to have announced suspension of its buying activity at the long end of the curve, and while it is still expected that BoJ will ease again over the next few months, the probability looks to have dropped from 90% to 60% over recent weeks.

Elsewhere, the ECB, BoE and perhaps even the PBoC are currently signalling or at least operating a more dovish stance than markets were anticipating even a few weeks ago and this has supported reflation of global capital flows. Indeed, we are seeing a resumption of flows into ‘cheap EM’, continued massive credit flows into China, and flows into peripheral Euroland.

Taken as a piece, we could attribute the recent positive performance of equities in Developed Markets, the rally in Emerging Markets, and the strong performance from fixed income markets to the provision of ample liquidity within the financial system, rather than positive progress in real economies, where pessimistically we could make a case for there being weak growth, rising inequality and a growing threat from deflation. It is against this possible backcloth that we need to worry that politics may move steadily towards creating an environment of more (economic) nationalism, more state interventionism, and ultimately such developments could undermine financial markets. Thus, unless general economic conditions improve, resentment of the financial sector can only increase and this may eventually force a (further) political reaction that may ultimately undermine the prosperity of the financial sectors.

James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla