PMIs Printing Higher
Global growth has been ticking higher over recent months with The speed of growth in global industrial production having more than doubled since early 2016 with the biggest increases seen in the advanced economies. Global manufacturing has registered its biggest expansion since 2014 with industrial production up 3.3% year over year in the three months to April, which is around 2% higher than the growth rate at the beginning of 2016. PMI readings in developed economies have risen from just above the key 50 level, at the starts of 2016, to an average of 54 in the latest three-month readings. Leading the pack is Europe, where PMI readings have been registering the highest levels.
PMI’s in emerging markets turned earlier in 2015 though have not yet risen to the level seen in developed economies. However, the increases are in line with a broad improvement in global industrial production.
In terms of drivers behind the improvement in global industrial production, let’s take a look at the key factors.
- 1 – QE in the eurozone has been successful in reinforcing the recovery and facilitating stronger investment and consumption. It also helped weaken the exchange rate
- 2 – Capital expenditure in the US has recovered following the plunge it suffered as a result of the oil price decline. The US rig count fell to a low of near 400 in early 2016 from around 1900 in 2014 and has since recovered back to around 900.
- 3 – Over late 2015, early 2016 US manufacturing took a downturn as a result of the sharp increase in the US Dollar which has since weakened again, alongside a boost in corporate risk appetite linked to the expected easing of regulation under the Trump administration.
- 4 – Capital utilisation has picked up with the eurozone seeing its best figures over the last three months since 2008. The scarcity of labour in some sectors in certain countries appears to be helping investment which might also be boosted by automation.
- 5 – The global economy looks to be far more aligned and synchronized than it was around 18 months ago with above-potential growth in many countries occurring alongside a pickup in growth in China.
Central Banks Have Motivated Markets
Since 2015, global central banks have been growing their balance sheets at a faster pace, fuelled by the ECB announcing a huge 1 trillion Euro QE program, marking a significant shift from prior years where the ECB had been shrinking its balance sheet. Firmer inflation linked to higher oil prices has helped weaken ex-post real interest rates and consequently stabilise inflation expectations. Furthermore, the passing of political uncertainty in Europe, linked to an increase in support for populist parties, has also helped.
Monetary conditions have been very loose globally and even in the US, where the Fed has raised rates, there has been an easing in financial and monetary conditions as a result of a weakening in USD and firmer asset prices. Similarly, Europe has benefited from easier monetary conditions despite a rising Euro. Looking ahead, industry is expected to pick up at a solid pace over central Europe in the coming months as a result of stronger domestic demand and an improving growth outlook both domestically and abroad.
Despite the positive outlook, there are some concerns which pose questions for next year. The Fed is widely expected to start shrinking their balance sheet before the end of the year, as noted in their last meeting. Alongside this, it looks increasingly likely that the ECB will announce further tapering of the QE, likely to begin in 2018 and end somewhere around the last third of the year. With the majority of banks in the G10 starting to shift towards a more hawkish view, the expansion in balance sheets looks set to reduce and eventually reverse over late 2018 and 2019. I
If the Fed’s tightening has a negative impact on emerging market currencies it will reduce their reserves, exacerbating the tightening in global central bank balance sheets. The shift in balance sheets will be most concentrated in the balance sheets of the Fed and the ECB, however this is an issue which should not plague markets in the short term and is more appropriate for the medium and longer-term picture.