There are two reasons why the world economy slowed down this year. The first is the slowdown in the eurozone: global trade with the eurozone has fallen off very sharply as the region has cut back on activity.
The second reason is that capital spending has been very weak. This came as a bit more of a surprise because companies have a lot of cash on balance sheets and are very profitable – so normally we would expect them to be spending more. They are being held back by uncertainty about the eurozone and the recent US election and the looming fiscal cliff.
Bright spots and damp squibs of 2012
The eurozone was a major drag on the global economy through 2012. We had an escalation of the eurozone debt crisis which caused bond yields to rise substantially throughout the peripheral economies. This meant that companies really struggled to borrow through financial markets which of course hurt their profitability and activity.
In addition, households struggled to borrow from banks. The banks themselves were asked to deleverage quite aggressively by the European Banking Authority and the European Central Bank. With consumers more strapped for cash, there was quite a substantial hit to demand for imports, dragging down the global economy.
The real game changer for the eurozone in 2012 was the European Central Bank’s president, Mario Draghi, who promised to do anything and everything to keep the European monetary union together.
As a result, the tails risks have reduced quite substantially for the eurozone, and we expect them to continue to do so in 2013. Political risk will of course remain, but the promise that the European Central Bank could step in and force markets to reduce interest rates is a real positive step and will actually reduce the tail risks for financial markets.
The prospects for the UK economy are entangled with the eurozone crisis because of the proximity of Europe to the UK. Of course exports to the eurozone have fallen. The UK market has also been impacted when confidence has taken a hit across Europe more widely. In the UK there is a debate developing around austerity versus growth. Now that the coalition government is heading into the second half of its term there is going to be more pressure placed on it to offer more solutions for growth and perhaps ease off a little bit on the austerity.
Obama succeeded in securing a second term of presidency in November against a very unpromising uneconomic backdrop. With the election now over the impending fiscal cliff has taken centre stage. In the beginning of 2013, there will be an increase in taxes of $600bn in the US - about 4% of GDP. This increase will occur unless the Republicans and Democrats can reach an agreement to delay some of these fiscal measures – and we are quite optimistic this will happen. If they allow taxes to increase by that amount, the US economy will certainly go into recession.
One brighter spot of 2012 was the US housing market. We have seen starts and prices increase quite significantly this year and people are starting to put money back into the US housing market – which was initially at the epicentre of the financial crisis.
Housing is beginning to contribute to growth again, which is quite important for a number of reasons. Firstly there will be more construction activity; secondly it means households are beginning to get more confident as they see prices rising again and thirdly an increase in prices helps bank balance sheets and makes them more willing to lend so it has quite a big effect on the overall economy.
The second bright spot is China and the emerging markets. We think there are signs that the Chinese economy is beginning to bottom out. The stimulus that the Chinese authorities put into place is beginning to bear fruit and we are seeing a pick up in activity. We are also seeing a pick up in activity in the wider emerging markets, such as Brazil, and as a result we think the emerging markets are beginning to look a lot brighter.
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