Global View
n Our Global Economics team recently issued a major report entitled “Global slowdown, local strength: Sources of demand in 2007” (September 13). The report examines how economies around the world are likely to fare as U.S. growth decelerates and what the investment implications of the slowdown are likely to be for equities, global fixed income and foreign-exchange markets, and commodities. We outline some of the highlights in the paragraphs below.
n The U.S. has been a key engine of global economic growth for nearly a decade. Now, the world economy can no longer rely on the U.S. consumer as a buyer of last resort, in our view. We expect a significant slowdown in U.S. growth, one that is likely to occur sooner and be more persistent than most observers currently think it will be. As we see it, U.S. GDP growth is likely to fall from 3.4% this year to 1.9% in 2007; as that occurs, non-U.S. global growth will probably moderate from 5.7% to 5.2%.
n Several countries appear to be very vulnerable to a U.S. slowdown because of their strong dependency on exports; but, in general, we expect the global economy to weather the U.S. storm well. The key sources of decoupling: independent domestic demand outside the U.S., which, in conjunction with the increase in intra-regional trade, creates pools of regional demand; and the ability of individual countries to implement supportive, offsetting macro policies. (By “decouple,” we mean that non-U.S. economies will have a smaller reaction to the U.S. slowdown than they have had historically, rather than an acceleration in growth.)
n We see several specific sources of local strength. They are Japan’s capital formation and consumer spending, China’s consumer demand, India’s consumption and business investment, Europe’s domestic demand in general and its business demand in particular, and the domestic demand of commodity- exporting countries.
n Here is a look at what we think is likely to happen in terms of regions and countries as the U.S. economy slows:
n Asia. Japan and India appear to be in a good position to decouple from the U.S. slowdown. Taiwan appears to be the most vulnerable, followed by Hong Kong and Singapore. China and Korea, although exposed, should be able to decouple if offsetting policies are implemented fast enough.
n Europe. The euro area is vulnerable, but the increasing dynamism of domestic demand suggests that it will weather the storm much better than it did in previous U.S. downturns. Emerging Europe is exposed, but it should find some cushion in the form of increased intra-Europe trade. Turkey is exposed, but Russia is well-positioned.
n The Americas. Canada is poised to be hit by the U.S. slowdown, but Brazil is set to decouple. Mexico is a mixed case, but, similar to the euro area, it stands to do better than it has in the past.
Equity implications
n As the economic growth patterns of regions and countries diverge, the premium for country and sector selection goes up. We like sectors that benefit from capital formation and consumer spending in Japan, consumer demand in China, consumption and business investment in India, domestic demand and business investment in the euro area, and domestic demand in commodity-exporting countries. We also think that the growth outlook favors Japan, China, the euro area, Brazil, and Russia rather than the U.S, Canada, Korea, Australia, Mexico, and Turkey (although we recognize that country selection decisions are not made on the basis of macro factors alone). Our equity strategists will be exploring those themes in subsequent reports.
Global fixed income and FX implications
n As the visibility of the U.S. slowdown increases, global monetary policy and capital flows are poised to change. As growth decouples, we expect more-pronounced divergences between the countries in Europe and Asia (including Japan) that will continue to normalize monetary policy and the U.S., Canada, Australia, and the U.K., which are likely to reverse course or stand pat as the slowdown proceeds. One element in our view is the world’s improved ability to withstand a U.S. slowdown. Another is that countries that have yet to normalize rates would find it difficult to reverse their monetary course in the face of higher inflation risks.