TalkingEconomics: The macro impact of China
With the risks of a hard landing in China rising we look at the threat a slowdown in the world's second largest economy poses to global growth and the outlook for interest rates in the US.
China tail risks have risen and are uppermost in investors’ minds.
The emerging markets would be most affected by a hard landing in China although developed economies such as Japan and Germany are vulnerable.
With central banks lacking firepower, the response will be to keep rates lower for longer and we have pushed out our first rate rise from the US to March 2016.
Our central view on China remains that the economy will continue to struggle in coming quarters, but will not experience a sudden collapse.
Nonetheless, the risk of a hard landing has risen. Analysis from macro models shows it is the emerging world that will feel the brunt of a China hard landing.
The transmission mechanism is initially through lower oil and metals prices which will hit the commodity exporters.
Investment is then cut in the commodity sector and by governments as fiscal constraints bite.
Looking in more detail at the country breakdown we can see that cutbacks in investment account for much of the reduction in growth in commodity-rich Brazil and Russia.
For India, it is a loss of exports that has the greater effect on GDP.
Amongst the developed economies, Japan is the most affected by nature of its close trade links to China (18% of exports).
However, Germany is not far behind and Italy is also quite vulnerable. Meanwhile, the impact on France, the UK and US is considerably less.
Reassessing the Fed rate path
The idea that monetary policy can underwrite growth for investors is becoming less credible as the authorities begin to run out of ammunition with which to respond to adverse shocks such as a Chinese slowdown, given that interest rates are already at, or close to, zero.
This would have been front of mind when the US Federal Reserve decided to leave policy rates on hold in September.
Although Chair Janet Yellen has said she expects to raise rates this year, the decision is data dependent and in the absence of a rapid turn in China and the emerging markets, this timescale seems unlikely.
We have now pushed out our forecast for the first rate rise to March next year and flattened the rate trajectory such that rates reach 1% by end 2016.
The change reflects the rise in the US dollar, greater global risks and a recognition that the Yellen Fed is simply über dovish.
World economy looking more like 1997
There have been a lot of comparisons with 2013 recently with the Fed ducking a decision to tighten policy in response to market pressures.
However, today’s environment seems more like that of the late 1990s when the Asian financial crisis triggered fears of global deflation and led to an extended period of low inflation and interest rates.
Today’s low inflation will also keep central banks on hold for longer and rates will not rise as much as expected, which will keep developed world growth skewed toward services and domestic activity.
The downside is that it could create more financial market bubbles (as in the late 1990s) and, given the low level of rates, currency wars may continue. Beware the risk of a further Chinese yuan devaluation.
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