Five years have passed since the global financial crisis. The IMF projects the world economy to increase 3.6% in 2014 and 3.9% in 2015. This is below the 5% growth of 2005-2007, but still a very good prospect.

 7th July 2014

Five years have passed since the global financial crisis. The IMF projects the world economy to increase 3.6% in 2014 and 3.9% in 2015. This is below the 5% growth of 2005-2007, but still a very good prospect.

The acceleration of growth will be provided mostly by the developed economies. Fiscal consolidation in these nations – tax hikes and spending cuts – is no longer as vigorous as it used to be. Investors are now less worried about the ability of these countries to manage their debt burden. Although inflation remains unpleasantly low, the real pace of the economic growth lags potential levels and the full-fledged recovery remains far away, in some places like the US and the UK normalization of the monetary policy is already on agenda. The improvement in the developed nations has direct impact on the emerging markets. On the one hand, higher demand in advanced economies encourages exports from the emerging ones. On the other hand, reduction in the US monetary stimulus is tightening financial conditions and makes the emerging market currencies suffer from the extremely high volatility.

US central bank has started reducing the bond-buying program in December. The reduction in American quantitative easing (QE) leads to the reduction in the cheap US dollar liquidity volumes. As a result, emerging markets have to adjust to the real American demand which isn’t as boosted by the consumer boom as it was in 2008. As a result, one of the main questions this year is whether the Fed’s Chairwoman Janet Yellen is able to taper QE and make a move towards increasing interest rates as painlessly as possible both for the US and global economy.

Advanced economies – the strong link

For the United States everything’s going rather well. The final quarter of 2013 was economically very successful – the growth equaled to 3.2%. The indicators for Q1 2014 are, of course, much worse. In January and February the world’s largest economy was hit by severe colds and snowfalls that resulted in lower economic activity. Still, the household balance sheets are in good order. Investors’ risk aversion led to the increase in demand for Treasuries which pushed the mortgage rates down. In addition, in 2014 we expect the decline in risks associated with US debt. In February the Congress suspended the debt ceiling limit until March 2015, while Fitch Ratings changed forecast for US credit rating from negative to stable.

While reducing QE the Fed is looking at the economic data and especially labor market figures. The decline in the US unemployment rate may be partly explained by the reduction in the labor force: many people lose hope of finding a job and stop being registered as unemployed. Still, the number of employed in the private sector for the first time exceeded the pre-recession peak. This year we can expect moderate strengthening of the US currency versus some of its partners.

According to the International Monetary Fund (IMF), the biggest growth among advanced economies will be shown this year by Britain which has so far been cheering investors with higher production and business activity. During the past year the pound has added about 10% showing the biggest growth among the currencies of the developed economies (see Bloomberg). The Bank of England has indicated that it may raise the benchmark rate rather sooner than later.

The euro area and Japan pursue another, easing type of monetary policy, but their economies have their positive moments as well.

The euro zone is able to show small but growth mainly due to the strong German economy. The European “outsiders” are also getting back on track: Greece has managed to make a triumphant return to the debt market, while Portugal has quitted the bailout program. However, deflation threat which is exacerbated by high euro led the European Central

Bank to step in with unprecedented monetary stimulus. The ECB President Mario Draghi even said that the regulatorplans to start buying asset-backed securities, though he didn’t specify when such operation may begin.

Japan increased the consumption tax from April 1. Such move may cost the nation 2.5% of GDP after it made higher than expected annualized increase of 5.9% in Q1. Although Japanese exporters benefit from the recovery in the main trading partners and the weakening of yen in 2012-2013, “Abenomics” (Shinzo Abe’s reform policy) still hasn’t brought tangible results and the Bank of Japan continues doing monetary stimulus despite the increase in inflation (core CPI added 3.4% in May). This year the decline in Japanese currency slowed down as the demand for it as a safe haven went up.

Emerging markets – the weak link

Monetary stimulus and, consequently, low yields in the developed nations have provoked in the recent years the inflow of “hot money” to the emerging market economies. Investors were lured there by higher interest rates. According to the IMF, investment from the advanced economies to the developing countries’ bonds reached $1.5T by the end of 2013. From 2009 to 2013 the corporate debt of the developing nations increased in 3 times.

Now the constant normalization of Western monetary policy leads to the opposite effect, and we are witnessing the outflow of capital from the emerging markets. One has to admit that these counties are now better prepared for self-defense than during the crisis in 1997-1998: they have more flexible exchange rates, bigger currency reserves and lower levels of debt and current account deficit.

The main threat for the developing economies is their vulnerability to the external factors, such as QE tapering in the US. At the same time, there’s still a considerable time before US rates will be increased. This gives the emerging market economies hope to adjust to the coming changes. The currencies of these nations will likely continue trading in a volatile fashion.

Elizaveta Belugina – Leading Analyst FBS Markets

China which consumes colossal volumes of commodities from Latin America, Africa, Russia and many Asian nations is another important factor for the emerging markets. This engine of the world’s economic growth has been moving forwards at the great speed, but in the past few years its advance has slowed down. The first Chinese corporate defaults mean that the country’s financial system has a very difficult period ahead. However, it’s too early to speak about China’s “hard landing”. For now it seems that the situation is under control of Chinese authorities who aim to change the nation’s economic model. Many market participants expect that if Chinese growth slows more than expected, the nation’s leadership will do stimulus measures and thus save the day.

According to IMF, economies of Argentina, Brazil, Columbia, India, Indonesia, Thailand and Venezuela are linked closer to China than to the euro area or the US, while the growth rate in Chile, Malaysia, Mexico, Russia and Turkey is more correlated with American growth. According to the OECD, this year the economic growth of India and Brazil will be below the trend level.

All in all, the economic community is sure that despite the negative factors and considerable uncertainty, global economy will show a confident recovery this year. Among the main risks the experts cite low inflation in advance nations, weak growth of the emerging market economies and high geopolitical tensions.

Source: FBS Inc