Cyclical outlook

PIMCO Cyclical Outlook: Synchronized Optimism

Many challenges to growth are gradually exhausting themselves or are being overcome via alternatives, yielding a brighter growth outlook for 2014.

The global economy endured several challenges in 2013; yet it still managed to maintain steady, albeit muted, growth.

In the United States, a deliberate tightening of fiscal policy was accompanied by a spike higher in interest rates just as the housing recovery was picking up steam mid-year.

In the eurozone, bank deleveraging accelerated in the face of already tight fiscal policy even as the economy remained in a recession for the year.

In Japan, households and corporations continued to adjust to their new reality of increased dependence on expensive imported energy.

In China, the emergence of shadow banking and runaway credit growth became the center of attention, yielding to tighter liquidity and credit conditions and a broad-based questioning of China’s future growth drivers.

And in other emerging market countries like Brazil, India and Turkey, weaker-than-expected economic performance combined with higher-than-expected inflation induced capital outflows, weaker currencies and ultimately higher interest rates.

Despite the diverse nature of these challenges, the global economy was able to grow between 2%–2.5% during the year, after adjusting for inflation, equaling its performance from 2012. The global growth story in 2013 was closely linked to the gradual healing in the U.S. economy – see, for example, notable recent improvements in the labor market and stronger household and company balance sheets, all of which has been underpinned by extraordinary central bank policies.

The new year promises to be a better year. Many of the challenges faced during 2013 have either progressed toward a point of self-exhaustion or are being overcome via alternatives to yield a brighter outlook for global growth in 2014. PIMCO expects the global economy to grow between 2.5%–3% next year.

In the United States, the abatement of fiscal policy tightening combined with steady improvements in labor market demand and higher asset valuations is likely to drive real economic growth from its current 1.8% rate toward 2.25%–2.75% next year. Included in this view are a continued improvement in demand for housing and consumer durables, somewhat faster household income growth and a small acceleration in non-residential investment growth on the back of extraordinarily easy financial conditions that benefit corporations.

Expect the eurozone to finally emerge from recession in 2014. With monetary policy clipping the nasty left tail of a sudden stop in eurozone growth, and fiscal policy transitioning from tight to broadly neutral, select steady improvements in competitiveness should see the private economy grow going forward, albeit very slowly. We expect eurozone growth of about 0.25%–0.75% next year.

Japan is likely to continue to grow in 2014 with the continued assistance of extraordinarily expansive policies. The lagged positive effects of easy monetary policy will be felt in steady consumption, higher investment and better net trade contributions. But, tighter fiscal policy via higher consumption tax rates will likely cap the growth trajectory somewhat as Japan looks to find ways to transition to a self-sustained growth path in the year ahead. Expect Japan to grow between 1%–1.5% next year.

In China, external demand will likely improve in 2014 as the U.S. and eurozone economies grow faster. Domestic demand will likely slow somewhat as a clampdown on extraneous investment feeds through the economy and the central government’s focus shifts away from “growth at any cost.” China, from an external perspective, promises to look and feel like a different economy in the year(s) ahead. Greater focus on China’s household demand and less focus on its industrial demand will change China’s impact on the global economy slowly but surely. We expect about 7% growth in China next year.

In other emerging markets, growth and inflation are expected to remain steady, with continued policy efforts focused on reducing inflation and raising real growth. While bouts of financial market volatility are likely to continue to be a stress point for certain emerging economies, we expect the major emerging economies (ex China) to grow by about 3% next year.

Global inflation will likely remain contained in 2014 due to several factors. Below-potential aggregate demand growth, still-sizeable output gaps, high unemployment rates and marked improvements in the supply-demand balance for energy will likely keep inflation rates below central bank targets in most economies.

What are the risks to this overall sanguine global growth and inflation outlook?

In the United States, a complicated exit from extraordinary monetary policy could dampen the housing recovery in 2014, as rising interest rates, higher prices and stagnant incomes undermine affordability. On the flip side, dramatically improved financial conditions for corporations could induce more risk taking in the form of faster capital expenditure growth and/or labor market demand in 2014.

In the eurozone, new stress tests for banks are likely to lead to further balance sheet deleveraging. On the margin, this means eurozone sovereigns will need to continue to improve their balance sheets in order to attract foreign investors, leading to generally tight fiscal policies and growth headwinds persisting for some time to come.

In Japan, consumption tax increases could offset the improvement in inflation expectations and dampen domestic demand growth more than we expect. However, this can and likely will be offset by supplementary fiscal stimulus if the need arises.

In China, non-performing loans remain a key but manageable risk. It’s the other emerging market economies that we are most concerned about. Returning these economies to their sustainable growth paths will require continued policy adjustments, both cyclical and structural. But with election years looming for many of these countries in 2014–2015, the probability of difficult decisions being delayed remains uncomfortably high.

Then there is the medium term, where the global economy needs to see a true transition from policy-driven solutions to aggregate global final demand in order for truly sustainable growth to take hold.


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