Our cyclical narrative finds that three C’s – China, commodities and central banks – dominate the outlook for the global economy and financial markets, and recent developments on all three fronts suggest that there may indeed be calmer C’s ahead, for now.
Starting with China, this month’s data releases show a stabilizing economy in Q1, with the official estimate of real GDP growth coming in at 6.7% year-over-year, in line with expectations and the official target of 6.5%–7.0% for 2016 (surprise, surprise!). More importantly, PIMCO’s estimate of the country’s Q1 GDP (a measure we developed based on economic data that we feel are less prone to “smoothing” than official GDP) rebounded from 5.3% in Q4 to 5.7% in Q1. This rise largely reflects the efforts by China’s authorities to reflate the property market, as well as a commodity-inventory restocking cycle, rather than an uptick in underlying growth. Still, with the economy less ugly, as least for now, and with the trade-weighted Chinese yuan having weakened further due to the strengthening of the euro and the Japanese yen against the U.S. dollar, the near-term risk of a disruptive devaluation of the yuan versus the dollar seems low, which should help to keep markets calm for now.
Regarding commodities, it was encouraging to see the very muted reaction in oil markets to Sunday’s breaking news from Doha that oil producers failed to reach an agreement on limiting supply. Our commodity team remains constructive on oil as demand is maintaining trend growth and production is starting to turn over, with disruptions in Nigeria, northern Iraq and Kuwait helping support prices.
Meanwhile, central banks continue to face a challenging environment for attaining their inflation objectives, which means that more dovish talk from the U.S. Federal Reserve and the European Central Bank (ECB) and potentially more dovish action from the Bank of Japan (BOJ) may lie ahead in the remainder of this month:
- The Fed’s main challenge is that the uptrend in core inflation seen over the past several months now seems to be broken. Thus, the progress on actual inflation toward the target that the March Fed statement cited as one precondition for further rate hikes has stalled for now. The combination of lower actual and expected inflation (as portrayed in recent surveys) will likely make Fed Chair Janet Yellen even less eager to continue anytime soon the cautious liftoff started back in December.
- A continuously (or even more) dovish Fed complicates life for both the ECB and the BOJ because it may put further upward pressure on the euro and the yen. With the ECB having just announced additional easing measures last month, further near-term action appears unlikely. Yet, ECB President Mario Draghi will have an opportunity this coming Thursday to try some verbal easing in the press conference following the ECB Council meeting.
- While the Fed and the ECB are all talk but no (additional) action for now, there is a very decent chance that the BOJ will announce further easing measures following the 27–28 April policy meeting. Governor Haruhiko Kuroda seemed to lay the ground for further action in a speech at Columbia University this past week, where he staunchly defended the January decision to take rates negative and said that the only limit for Japanese government bond (JGB) purchases was the size of the public debt. In other comments, he called the recent rise in the yen “excessive,” which was new language. Based on these messages and my discussions with investors and colleagues in Tokyo, I find it likely that we will see a BOJ easing package in late April with a bit of everything included: a moderate rate cut, more JGB purchases of longer maturities, more ETF purchases and more TLTRO-like cheap funding for the banks (TLTRO = targeted long-term refinancing operations).
Bottom line: Calmer C’s – China, commodities and central banks – should bode well for a fourth C – corporate credit.