Wells Fargo Investment Institute - Global Investment Strategy
Global Macro Strategy Report
February 17, 2016
Global Research Analyst
Paul Christopher, CFA®
Head Global Market Strategist
Analysis and outlook for the global economy
- We have lowered our global gross domestic product (GDP) growth forecast for 2016 due to the sharp fall in oil prices and associated slowing in manufacturing.
- The plunge in oil prices likely will keep headline inflation low in the developed world and undercut pricing more than expected throughout 2016. Consequently, we have reduced our developed-market inflation targets.
- Weaker fundamentals and uncertainty around foreign central-bank policy has led to a reduction in our year-end dollar-euro target.
What it may mean for investors
- We continue to expect modest economic growth and gradual normalization in inflation around most of the globe this year.
Economic Headwinds Have Dampened 2016 Growth Prospects
Global economic concerns, particularly an economic slowdown in China, have dampened our outlook for 2016. These growth concerns, along with excess supply, have contributed to the recent fall in the price of oil and other commodities. This sharp drop in commodity prices has exacerbated economic weakness for commodity-exporting economies such as Brazil and Russia, thus lowering our GDP forecast for emerging-market economies.
Table 1: Global Gross Domestic Product (GDP) Growth Forecast, Selected Countries
Source: Wells Fargo Investment Institute, 2/16/16
We have seen similar growth concerns in developed economies. Japan is battling deflationary pressures from the strengthening of the yen and low commodity prices. The Eurozone continues to recover, but we expect further economic stimulation in the region in effort to curb the impact of the global slowdown. In the U.S, manufacturing sentiment, measured by the Institute for Supply Management (ISM) index, contracted for the fourth consecutive month in January. The soft patch in manufacturing is due to weakness in the oil industry, the stronger dollar, and weak global growth. Together, these factors have weakened demand for U.S. exports and added stress to economic growth.
There have been some positive data points. New orders and production improved, potentially signaling that the U.S. manufacturing contraction could ease in the near term. Consumer confidence remains in an uptrend (Chart 1), and rose in December and again in January. Consumer spending remains on a positive trajectory. The labor market remains intact, with the unemployment rate dropping to its lowest level since before the financial crisis.
Chart 1: Consumers Remain Optimistic about the U.S. Economy
Source: Bloomberg, Wells Fargo Investment Institute, 2/16/16
Economic headwinds spilling over from 2015 have been more prominent than we initially expected, but we also believe that they will be transitory. In our view, the latest sharp decline in oil prices, dating from late 2015, has been the most significant cross-current for the global economy. In fact, the drop in oil prices accounts for nearly all of our downward revision to global growth, whether directly (in the cases of Brazil and Russia), or through trade and manufacturing (for Taiwan, Japan, and the U.S.). However, global oil-supply growth has already slowed and is now lower than the pace of rising oil demand, a notable development that we believe puts the bottom in oil prices close by. We expect a rebound in oil prices this year, and also expect U.S. manufacturing to return to stronger growth. Consequently, our growth revisions are to account for what has occurred in the past four months and does not reflect our view of a weaker trend for the year as a whole.
Global Inflation Forecast Adjustments
Oil also plays the main role in our 2016 global inflation forecast revisions. Oil prices in the range of $30 to $40 per barrel reduce import costs among the developed economies and cool U.S. manufacturing activity. We see U.S. headline inflation reaching 1.4 percent by year-end 2016, below our previous estimate of 2.0 percent. For developed economies, including the U.S., we expect inflation to rise in 2016 but by less than we previously projected (1.3 percent vs. 1.7 percent previously). On a brighter note, we believe that oil prices are near a bottom and, once it is reached, the downward pressure on domestic inflation should subside. As oil and commodity prices stabilize, we expect inflation to continue to slowly normalize.
Emerging-market economies have reflected mixed inflation concerns. Those that are net commodity importers may see reduced inflation, but commodity exporters such as Russia and Brazil have suffered large currency depreciations, which raise the cost of imports in Russia and across most of Latin America.
Table 2: Inflation Forecast, Selected Countries
Source: Wells Fargo Investment Institute, 2/16/16
Currency Forecast Adjustment
We continue to expect the dollar to strengthen from the end of 2015 to the end of 2016. Yet, the fundamental trends in favor of dollar strength may be somewhat weaker as a result of developments in the past several months. In particular, we believe that U.S. growth will slow, though still outpace our forecast for all developed economies. Finally, further Eurozone and Japanese monetary stimulus is likely, though the timing and the amounts are yet to be determined. Considering the fundamental revisions, and acknowledging the uncertainty around foreign central-bank policy, we reduce our estimates of dollar strength. Our euro target range (dollars per euro) is now $1.04 - $1.08 vs. $1.00 - $1.04 previously, and our yen target range is 117 yen (per dollar) to 122 yen, vs. our prior range of 127 yen – 131 yen.
Table 3: Currency Forecasts
Source: Wells Fargo Investment Institute, 2/16/16
We see the principal risk to our view as the possibility that the dollar may weaken further than it has since late January. If we begin to see U.S. consumer confidence undercut by current market weakness, or if commodity-price volatility and policy uncertainty in China persist, the dollar could weaken beyond current levels. Under those conditions, the Bank of Japan and the European Central Bank may fail to weaken their currencies by any new interest-rate cuts.
Despite the challenges that the global economy faces, we continue to expect modest economic growth and gradual nominalization in inflation. A more persistent slowdown in manufacturing, or a new decline in oil prices, could add more downward pressure to inflation and economic growth, but we believe that the probability of a recession this year remains low.
There is no assurance that any of the targets, forecasts or other forward-looking statements mentioned will be attained. Targets and forecasts are subject to change.
Institute for Supply Management Manufacturing Index (ISM) is based on surveys of more than 300 manufacturing firms by the Institute of Supply Management. The ISM Manufacturing Index monitors employment, production inventories, new orders and supplier deliveries. A composite diffusion index is created that monitors conditions in national manufacturing based on the data from these surveys.
The Conference Board Consumer Confidence Index ® (CCI) is a barometer of the health of the U.S. economy from the perspective of the consumer. The index is based on consumers’ perceptions of current business and employment conditions, as well as their expectations for six months hence regarding business conditions, employment, and income.
The Expectations Index is a sub-index of the Consumer Confidence Index. The index measures overall consumer sentiments toward the short-term (6-month) future economic situation.
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