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Fixed-Income Insights

Here’s a look at growth prospects for the United States, the eurozone, Japan, and China in the coming year. 

 

In Brief

  • What can investors expect from the four major global economies as 2016 unfolds? Here’s a look:

    1) United States—The United States looks poised for better growth in 2016, even with the prospect of gradual rate hikes from the U.S. Federal Reserve.

    2) Eurozone—Additional stimulus measures  should allow for a comparative "economic lift-off" in the eurozone from the anemic level of about 1.5% that characterized much of 2015.

    3) Japan—Policy responses by Prime Minister Shinzo Abe and Bank of Japan governor Haruhiko Kuroda are not assured, but more aggressive solutions to address weakness in Japan's economy and inflation seem likely.

    4) China—As aggressive reductions in bank reserve requirements and interest rates seem to have had little impact, China's response to economic weakness in 2016 will have important consequences.

  • The key takeaway—In 2016, we expect collective monetary and fiscal responses in the eurozone, Japan, and China to combine with an improving U.S. economy to produce a slightly better global economic environment than in 2015.

 

With an eventful 2015 nearly in the books, investors are turning their attention to the prospects for the coming year. Will 2016 bring better tidings for the global economy and markets? We think the prospects for global growth in 2016 will be shaped by stimulative central bank-policy moves in the eurozone and Japan, improvement in the U.S. economy, and resolution of an apparent slowdown in China. The policy responses and economic outcomes of these regions should allow world economies to expand at a slightly faster pace than 2015.

Here, we take a look at the factors that will influence the world’s major economic players in 2016:

United States
The United States looks poised for better growth in 2016, even with the prospect of gradual rate hikes from the U.S. Federal Reserve (Fed). Wage growth should enable consumption to improve, while a resumption of growth in government spending should also support some economic expansion. A slight improvement in the U.S. economy could help other economies, including many emerging markets that benefit from U.S. growth. 

The U.S. economy’s performance in 2016 will benefit from a variety of influences. U.S. growth in 2015, while similar to that of the past few years, was dampened by consequences of dollar strength and the drop in oil prices. Dollar strength reduced exports and, in the process, manufacturing. Lower oil prices hurt exploration and production in the energy sector, as well as many of the service businesses providing support to energy producers.

In 2016, as the U.S. dollar strengthens at a slower pace, and oil prices stabilize, the adverse impact on the U.S. economy will lessen. For instance, while the dollar may rise as a result of European Central Bank (ECB) stimulus and Fed policy tightening, the move is likely to be less than what took place during 2015, when the euro moved from $1.40 to around $1.10 to the U.S. dollar. While the price of oil fell from more than $100 per barrel in late 2014 to $40–45 per barrel in late 2015, a price move of similar scope in 2016 seems unlikely. Reducing the impact of these two factors, dollar strength and falling oil, could translate into improved year-over-year gross domestic product (GDP) for 2016.

More important to potential economic improvement may be consumer spending. The October and November jobs reports finally revealed what many Fed members had been expecting: a rise in wages. Despite persistent job growth over the past few years, and a decline in the unemployment rate to 5.0%, wage growth was unable to rise much above 2.0%. Finally, in October, wages showed a year-over-year increase of 2.5%, which was reinforced by a 2.3% rise in November. The November report also revealed an increase in the participant rate, a solid nonfarm payrolls number of 211,000, and an upward adjustment to October jobs growth, from 271,000 to 298,000. Wage pressures will persist as unemployment continues to decline and employers find it increasingly difficult to fill job openings. The number of applicants per job opening has declined, from 6.8:1 in 2009 to 1.4:1 in the past two months, suggesting a tighter labor market and continued wage increases in 2016. 

Higher wages should translate into increased consumption above the persistent level of 3.2% that characterized the past year, adding to GDP growth. This seems especially likely in an environment of increased purchasing power with imported goods cheaper and fuel prices stable at relatively low prices. This potential wage increase also coincides with a period during which consumers reduced their debt and increased their savings, enabling additional consumption as wages rise.

Business spending does not seem in the same position as personal consumption. However, to the extent business outlays were compromised in 2015 by reduced investment within the energy and mining sectors, year-over-year comparisons should be more favorable in 2016. A strong consumer also may convince purchasing managers that additional business investment may support and improve sales.

Housing has been another source of U.S. economic strength, and seems poised to make a similar contribution in 2016. Whether single or multi-family housing, continued modest price strength and increased household formation should keep this sector a pillar of U.S. economic strength. A dramatic increase in interest rates is a risk that could dampen demand, but the intended slow pace of Fed rate hikes should not adversely affect sales in 2016.

Finally, government spending is positioned to contribute to economic growth in 2016. After years of austerity, November's budget agreement increases spending by $50 billion in 2016 and by an additional $30 billion in 2017. The increase, split between defense and domestic programs, should provide an economic boost that will differentiate 2016 and 2017 from the past few years. A highway spending bill is also gaining momentum, which would involve outlays of $18 billion through 2018. The Trans-Pacific Partnership trade agreement is also under bipartisan consideration. If enacted, this too could provide an economic benefit to companies that have had difficulty exporting to countries with regulatory hurdles or other protectionist policies.

In a presidential election year, talk of tax reform, reduction of regulation, and changes to entitlements likely will gain attention as campaign issues, but are unlikely to attain passage. Nonetheless, such discussion would breed hope and optimism, as well as the type of animal spirits, that could push up equity prices in anticipation of any legislative action in 2017.

Eurozone
European Central Bank president Mario Draghi, on December 2, increased the already huge stimulus program by cutting the bank deposit rate to -0.3% from -0.2% and extending the quantitative easing (QE) program until March 2017, or "beyond if necessary." While investors had helped for even more stimulus, the additional bank lending and increased export activity resulting from these measures should allow for a comparative "economic lift-off" in the eurozone from the anemic level of about 1.5% that characterized much of 2015. An improved performance from eurozone economies should help boost global growth. 

Japan
Similarly, Japan seems faced with challenges that demand monetary and fiscal response to recent economic weakness. The continuation of one of the world's most aggressive programs of monetary stimulus needs to be supplemented with additional fiscal policy—and long-promised structural reforms—in 2016 if growth and inflation objectives are to be attained, and not postponed yet again. Policy responses by Prime Minister Shinzō Abe and Bank of Japan governor Haruhiko Kuroda are not assured, but more aggressive solutions to address persistent weakness in Japan's economy and inflation seem likely. This should contribute at least marginal improvement to global economic growth.

China
Continued weakness in China's exports, combined with soft credit demand, create the perception that the level of real economic growth is far lower than the most recent official release of 6.9% from the National Bureau of Statistics. Four reductions in bank reserve requirements and six cuts in benchmark interest rates over the past 13 months seem to have done little to contain the slowdown. Retail sales growth of more than 11% in October, capped with impressive "singles day" sales of more than $14 billion on November 11, according to data from consumer intelligence company Bomoda cited in a CNBC report, is encouraging, but this is not enough to reverse investor concerns or offset manufacturing weakness. 

China's response to economic weakness in 2016 will have important consequences. Traditional growth solutions, such as infrastructure spending and property incentives, may unfold, and could help mitigate economic weakness. On the other hand, a currency-devaluation solution likely would provoke similar policy responses by other Asian countries, compromising global growth in the process. The impact of weakness in China on global growth in 2016 seems dependent upon their policy response. Beijing’s desire to promote the yuan as a global currency is one argument that favors policy solutions other than devaluation, and, accordingly, those solutions will be more favorable to global growth in 2016.

Summing Up
Together, a variety of contributors to economic growth seems poised to provide slightly more punch to the U.S. economy in the coming year. Consumer spending and government spending appear best positioned to make a positive difference in 2016. Business investment may not be a major contributor to a better economy, but it should at least provide a measure of support. Housing should continue to aid the economy, though higher interest rates may provide a headwind. Fed policy may be the one headwind to dampen the party. More important, however, is that the Fed's role this time round is not to remove the punchbowl but to make sure the celebration continues without the need to end it abruptly.

We expect collective monetary and fiscal responses in the eurozone, Japan, and China to combine with the expected improvement in the U.S. economy to produce a slightly better global economic environment than we have seen in 2015. Investment opportunities will be uneven as currency weakness in one area may produce the opposite influence elsewhere.

 

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