“After a decade of ever-expanding quantitative easing from central banks, September marks a peak and in October, the combined balance sheet of the US, Eurozone and Japan will start to shrink”
– Richard Jerram, Chief Economist, Bank of Singapore; Member of OCBC Wealth Panel
October sees the next stage of policy tightening in developed markets as central bank balance sheets start to contract.
The Federal Reserve went into reverse with quantitative tightening (QT) to cut the size of its balance sheet. It has been gradually stepping up the pace and it will reach maximum velocity of US$50 billion shrinkage per month from October this year.
The European Central Bank (ECB) will also cut back its monthly asset purchases from €30b to €15b, before halting altogether at the end of the year. Japan has been targeting bond yields rather than a specific volume of purchases for the past couple of years. Its QE looks set to run at a US$20-30b monthly pace; much slower than a few years ago.
All these mark another rung down the long path of normalisation after the crisis of a decade ago, and so far, the process has not involved any serious disruption to major economies or financial markets.
Fiscal stimulus should support continued strong growth in the US into 2019. After eight rate hikes, monetary policy is gradually becoming less supportive, but is not set to edge into restrictive territory for about another year. Growth prospects look less certain in 2020, with the possibility of a meaningful drag from both fiscal and monetary policy.
Wages are starting to show a more pronounced upward trend, as the tightest labour market in decades shift bargaining power towards workers. Record numbers are quitting in search of higher incomes. Firms are absorbing some of the increased wages on their profit margins, but the Federal Reserve will recognise that there is growing pressure to pass on higher costs to consumers. With core inflation already at its 2% target, the Fed is likely to continue to tighten through to the end of 2019, but it is a slow-moving change and the current pace of one hike per quarter looks sustainable.
Even after the latest round of 10% tariffs on US$200b of imports from China, this scale of trade friction is not likely to have a material impact on the US$20 trillion US economy. However, escalation is still possible and complaints over the automobile sector remain unresolved. Trade policy is controlled by the President, so should be largely unaffected by the result of mid-term elections.
Growth in Europe has cooled from the unusually rapid pace seen in late 2017. However, it is still strong enough to continue to pull down the unemployment rate, which has reached levels where it is starting to boost wages. So far, consumer price inflation has not seen much impact, but the ECB seems confident that it will pick up as the cycle continues to mature.
Brexit negotiations remain fractious, both inside the UK and with the European Union. The political bargaining process is due to intensify in coming months, with compromises needed to produce a rough framework agreement that will open the way for a more detailed deal after the March 2019 deadline.
The economic recovery in Japan remains solid and is driving record levels of corporate profitability. However, the prospect of further structural reform looks limited. Even though Prime Minister Shinzō Abe is set to remain in office for another three years, his focus seems to have shifted away from economic issues.
US tariffs are now hitting US$250b of Chinese exports, with the threat of more to come. Restricted access to Western technology will be a further impediment to growth, albeit one that is hard to quantify. To offset the hit to the economy, China is loosening policy with tax cuts, easier access to credit and increases in infrastructure spending, which should limit any slowdown in growth.
Exports are only around one-fifth of the overall economy, so stimulating domestic demand should offer some balance. It is likely to come at the cost of further increasing the debt-to-GDP ratio, but this is a longer term concern that is secondary to the short-term imperative of maintaining an adequate pace of growth.
Rising US interest rates present a challenge for emerging markets where an external deficit results in significant funding needs. Fortunately, this only applies to a small number of countries, led by Argentina and Turkey which have already started to implement policies to rebalance their economies.
Asia looks relatively well-placed to withstand the pressure from higher US interest rates, as most countries run an external surplus. As the two main deficit economies, Indonesia and India face some strains, but policy is already responding prudently. US tariffs on Chinese exports are a risk, as a lot of the region’s exports to China are ultimately dependent on US demand, but this is offset by the possibility of taking market share from China when selling directly to the US.
In Asia, general fiscal positions are solid, inflation is under control and imbalances are limited. These mean that most of the economies in the region have enough policy flexibility to respond to external pressures and to limit the overall impact on growth.
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