The UK will be living the consequences of Brexit for years to come – yet the rest of the world seems to have moved on. At least that is the conclusion you would draw when observing recent moves in global stock markets. That said, there is no getting away from the fact the global recovery is still heavily dependent on growth in the US and the extreme efforts of central banks.
There was a fear, in the days after voters chose to take the country out of the European Union, that the UK’s troubles would sink the global recovery. But whatever the political risks investors quickly decided that for stocks and bonds this shock was actually a win-win. Why? Because growth would not be much affected outside the UK but central banks were likely to keep policy looser than it would otherwise have been, just to be safe. That explains why many stock markets reached new highs during the summer — even in the UK.
A year ago the obsession was China. You will remember that stock markets fell around the world when the Chinese authorities announced a surprise depreciation of the yuan against the US dollar. The fear was that a deflating Chinese economy would export its falling prices to the rest of the world via a lower exchange rate and take another bite out of growth in emerging markets.
On the surface, China’s economy does look less scary than it did a year ago. Keep in mind, though, that the authorities are using the same tools to support growth that they have used in the past: public investment and subsidised credit. Fixed asset investment by state-owned companies grew by more than 20 per cent year-over-year during Q2 2016.
Many observers would say China is not any closer to resolving its structural and financial imbalances than it was a year ago. This latest depreciation also means the country is still exporting disinflation to the rest of the world via a weaker exchange rate.
The US can probably shrug off the disinflationary effect of cheaper Chinese imports because domestic prices — and, finally, wages — are now picking up as the consumer-led recovery continues to move ahead. Globally, however, the picture is not nearly so strong. The International Monetary Fund’s latest forecasts show global consumer inflation at just 0.7 per cent in 2016. It is striking that the US and UK have the only central banks in the developed world that are expected to achieve inflation at or above their targeted two per cent by 2017.
It would be good news for the emerging world if global — and especially US — monetary policy were looser in 2016 than most had expected at the start of the year. However, investors who have been flocking to buy emerging market assets in the past few months should be wary of making a long-term bet on these economies solely in response to short-term expectations about the Federal Reserve.
Brazil and Russia may now be past the worst of their recent economic stumbles, but they and other emerging markets are still struggling to produce strong domestic demand growth, and in most of these countries the average growth in corporate earnings has yet to pick up.
None of this suggests the global recovery is about to grind to halt. In fact, recent data suggests the US economy is doing a little better than our fears would have led us to expect a few months ago. What is more, the eurozone seems to have been less affected by the immediate shock of Brexit than many had predicted. But growth – at around 1.6 per cent – is lower than the region needs to move out of its reliance on super-loose monetary policy.
The bottom line is that – despite the more upbeat tone of recent data – emerging markets are not ready to be the main engine of global growth. That leaves the world still heavily dependent on the US and the super-loose policies of its central bank.
With help from the Fed, the US has managed a respectable recovery, despite a needy global economy and an unhelpful rise in the dollar. So far the signs are that this recovery is doing just fine – even considering the disturbing noises coming out of the presidential campaign. We should all hope that continues to be the case because, right now, the world does not have much of a Plan B.
Stephanie Flanders is chief market strategist for Europe at J.P. Morgan Asset Management