Adverse Weather and Currency Movements Dull Short Term Global Outlook
The global economy is facing subdued growth in the short term, as adverse weather and a stronger currency have slowed the pace of U.S. expansion. Unusually severe winter weather on the U.S. East coast restricted business and consumer activity during the first three months of the year. In addition, recent U.S. Dollar gains against other global currencies continue to hurt the earnings outlook of corporations with large international operations. Weaker earnings could potentially discourage such corporations from making additional investments in capacity as well as hiring new employees. Nevertheless, U.S. consumer sentiment remains healthy and should support the economy in the coming quarters.
The Euro-zone continued to see encouraging signs of a moderate economic recovery, helped by export gains as well as a revival in domestic consumer demand. Shipments from the Euro-zone increased 4 percent in February and the trade surplus also widened as imports were mostly unchanged. Retail sales data has seen healthy gains in recent months, especially in Germany. The European Central Bank’s quantitative measures are expected to help business and consumer sentiment in the coming months. Japanese export growth has also accelerated this year, helped by the weaker currency, though domestic demand is yet to see appreciable gains. In the U.K., the relative strength of the British pound against the euro has led to subdued export trends.
After two months of gains, global equity markets saw a modest correction during March. Though select Asian markets such as China continued to advance, markets in Europe and the Americas corrected as investors turned more cautious. Global manufacturing and services activity continued to expand, helped by gains in the U.S. and the Euro-zone. New order flows also remained healthy, and suggest that the current trends could continue in the coming months.
Emerging Markets Equities See a Small Correction Hurt by Declines in Europe and Latin America
Emerging market equity indices saw a moderate correction as declines across Latin American and European markets more than offset the sustained strength in Asia. After the short recovery at the beginning of this year, oil prices resumed the decline while prices of industrial commodities such as iron ore continued to drift lower. These trends dented investor sentiment in Latin America, the worst performing region during the month. In addition, heightened political risks after large public protests in Brazil increased anxiety. Lower oil prices led to a correction in Russia, but the country ended the first quarter as one of the top-performing markets. Greece and Turkey were the two European markets that came under the most selling pressure, as political risks increased. Meanwhile, Chinese equity prices continued to advance as investors were encouraged by relatively low valuations and expectations about economic growth stability. Indonesia and Korea also ended the month with moderate gains while India, one of the top performing markets over the last twelve months, saw a correction.
Manufacturing activity moderated across most large emerging economies during the month of March. China, Korea and Indonesia were among the Asian countries reporting slower factory output growth. In Latin America, output declined further in Brazil while Mexico reported a slower pace of expansion. Russia continued to face challenges in the manufacturing sector, while South Africa returned to growth after the subdued trends at the beginning of the year. India remained a bright spot as manufacturing output growth and new order flows accelerated during March. Growth in services activity moderated in China and India, while Russia and Brazil continued to report declines.
Emerging Markets Near-Term Outlook
While softer U.S. growth during the first quarter of this year likely cooled the export growth outlook for some emerging market economies in the short term, the longer-term picture appears more promising. It is likely that much of the recent U.S. growth moderation has been due to adverse weather, as the robust labor market gains and low fuel prices continue to keep consumers optimistic. This should lead to demand expansion in the coming months, and benefit the exporters of consumer goods from Asia and Latin America. The U.S. Dollar strength also works in favor of these exporters as it gives them a meaningful price advantage. In addition, the Euro-zone economy is also showing signs of recovery and retail sales have seen consistent gains in recent months. Higher consumer demand in the Euro-zone could help strengthen the export growth outlook for select emerging countries. However, the euro depreciation could limit the gains for China as the country’s currency is pegged to the stronger U.S. Dollar.
The prospect of further interest rate cuts and other supportive monetary policy measures by central banks could help support domestic demand in many emerging economies, especially China, India, South Africa and Indonesia. Low oil prices have brought down inflation to comfortable levels, except in countries such as Brazil that have deeper structural issues. In addition, the fiscal health of governments has generally stabilized and even improved in India and select other countries. This should give central banks more flexibility to roll out additional pro-growth monetary measures later this year. Concerns about reduced liquidity flows into emerging countries have also eased, as it appears that the U.S. Federal Reserve is more in favor of measured interest rate hikes.
International Equities See a Moderate Correction in March as Growth Concerns Hurt Sentiment
After the positive start to the year, international equity prices saw a moderate correction in March. Renewed concerns about slower than forecast global growth reduced investor optimism during the month, though most of the subdued data trends are likely due to weather related disruptions in the U.S. and other major economies. At the same time, weaker growth has further reduced market concerns about an interest rate hike by the U.S. Federal Reserve in June this year. Markets in Europe underperformed after the excellent gains during the first two months of the year, as investors turned more cautious.
Emerging markets also corrected during the month, as Latin America and Europe saw declines. Select Asian markets, led by China, continued the uptrend during the month. Global manufacturing output growth during March was almost unchanged from the previous month. There were notable gains among the Euro-zone countries, though output expanded at a slower pace in select Asian countries. New order flows to the manufacturing sector remained healthy and should help sustain output growth in the coming months. Further gains in the U.S., the U.K and the Euro-zone helped sustain global services activity growth during the month.
International Equities Near-Term Outlook
Recent economic data from the Euro-zone show moderate signs of improvement, led by export gains as the weaker currency has made shipments more competitive. Lower energy import costs have widened the region’s trade surplus, and should continue to lift aggregate growth. Retail sales have also seen moderate gains, as the labor market in large countries such as Germany continued to improve. Manufacturing activity surveys have also shown gains in March, underlining the improving demand outlook. The ECB’s new bond purchase program has lifted both business and consumer sentiment, and could help revive credit growth in the coming quarters.
Negotiations between Greece and the European Union about extending the emergency funding to the debt-laden country are yet to reach a definitive agreement, and could pose a risk to financial market stability and business confidence in Europe. Unless a mutually acceptable agreement is reached soon, fears about a possible Greek exit from the euro could dampen market optimism in the near term. However, the real negative impact on the Euro-zone from a Greek exit is likely to be limited, considering the relatively smaller size of that economy.
The Japanese economy is also benefiting from export gains, as external demand has shown some improvement. The yen has weakened further, and continues to aid large Japanese manufacturers that are also the country’s leading exporters. While domestic demand has not yet seen a meaningful recovery, consumer sentiment is expected to remain healthy as the central bank’s quantitative easing measures continue. In addition, domestic consumer optimism should also get a lift from higher equity prices as the large Japanese pension funds continue their shift away from bonds and into equities.
Economic growth in Canada and Australia is likely to remain subdued in the coming quarters as these countries absorb the fallout from lower oil and commodity prices. Though their currencies have declined against the U.S. Dollar recently, it is hardly enough to boost exports when overseas demand for energy and industrial commodities is not healthy enough. Nevertheless, central banks in both countries reduced benchmark rates during the first quarter and the lower borrowing costs should help domestic demand in the coming months.
GLOBAL INDUSTRY SPOTLIGHT FOR THE MONTH: ENERGY
Global oil prices have made a moderate recovery from the lows set at the beginning of this year. Signs of slowing production and expectations about healthier demand have helped the energy market outlook, but prices remain significantly below last year’s levels. It is likely that the recent positive trends are not robust enough to ensure a sustainable recovery in oil prices over the medium term. The expected fall in production could be less meaningful as producers start accepting lower returns. In addition, demand growth could be subdued as energy supplies from non-conventional sources continue to rise and new technologies are pushing up fuel efficiency. Nevertheless, the price volatility and low equity valuations could encourage more industry consolidation as the larger corporations look for opportunities to strengthen their market position.
After one of the steepest ever falls during the last few months of 2014, oil prices have seen a moderate rebound in March. Select indicators of current and future oil production activity suggest that output could decline later this year as well as next year. The number of active oil rigs in the U.S., considered one of the most important barometers of future production, has been steadily declining. This was anticipated, as shale oil fields with high production costs could find it difficult to maintain output at current price levels. As the increase in U.S. production accounted for the bulk of output gains that triggered last year’s price fall, signs of weakness in U.S. oilfield activity are seen as positive for the energy price outlook.
However, the increased efficiency of oil rigs could also be the reason for their lower numbers in use since last year. Data from the U.S. Energy Information Agency indicate that while aggregate production from shale fields has declined, output per oil rig continues to rise for newer wells. This means that the newer wells are likely to be commercially viable at lower oil prices than thought earlier.
In addition, production in other parts of the world could rise further in the coming months. Saudi Arabia, one of the top-three producers, has stepped up production volumes to compensate for lower prices. If the ongoing negotiations between the U.S. and Iran lead to a withdrawal of economic sanctions against the latter, global supplies could increase even more.
Furthermore, renewable energy sources are becoming increasingly price competitive. Despite low oil prices, investment flows into non-conventional energy continue to be strong and sources such as solar and wind energy could become even more price-competitive as current investments start yielding results. Global investments in renewable energy scaled a record high of $270 billion in 2014, according to the United Nations Environment Program. Though investments have declined during the first quarter of this year, aggregate investments remain significantly large when compared to earlier years.
Nevertheless, weak market conditions could lead to a wave of consolidation in the energy industry. Weaker and inefficient producers are likely to be acquired by larger rivals that have the ability to invest in new capacity, as well as improve the efficiency of existing production facilities. The larger integrated energy companies also have access to superior technical skills, and are in a better position to explore and start production from reserves that are difficult or costly to bring to the market. The first quarter of this year has already seen the biggest oil sector merger for the last several years, and the trend is likely to continue.
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