Fragile and Under Threat

Those are the International Monetary Fund (IMF)’s words, not mine.

They recently used them to describe the current global expansion.

Their exact words were ‘global expansion still strong but less even, more fragile, under threat.

The fund is still projecting global growth to reach 3.9% this year and next. Yet the expansion is becoming less synchronised, and there are increasing risks.

As they noted on their July 2018 World Economic Outlook report:

As the global cyclical upswing approaches its two year mark, the pace of expansion in some economies appears to have peaked and growth has become less synchronized across countries. Among advanced economies, growth divergences between the United States on one side, and Europe and Japan on the other, are widening. Growth is also becoming more uneven among emerging market and developing economies, reflecting the combined influences of rising oil prices, higher yields in the United States, sentiment shifts following escalating trade tensions, and domestic political and policy uncertainty.

As they mentioned on the report, one of the big worries is trade tensions.

The balance of risks has shifted further to the downside, including in the short term. The recently announced and anticipated tariff increases by the United States and retaliatory measures by trading partners have increased the likelihood of escalating and sustained trade actions. These could derail the recovery and depress medium-term growth prospects, both through their direct impact on resource allocation and productivity and by raising uncertainty and taking a toll on investment. Financial market conditions remain accommodative for advanced economies—with compressed spreads, stretched valuations in some markets, and low volatility—but this could change rapidly. Possible triggers include rising trade tensions and conflicts, geopolitical concerns, and mounting political uncertainty. Higher inflation readings in the United States, where unemployment is below 4 percent but markets are pricing in a much shallower path of interest rate increases than the one in the projections of the Federal Open Market Committee, could also lead to a sudden reassessment of fundamentals and risks by investors.

Worries About Higher Oil Prices

The IMF also noted there are worries about higher oil prices.

There is turmoil in many of the oil exporting countries, like Venezuela, Libya and Iran.

The US has withdrawn this year from the Iranian nuclear deal. The deal was a way to stop Iran from acquiring nuclear weapons capability.

They are looking to impose sanctions on Iran by November.

Rising tensions and trouble in oil exporting countries could affect oil prices. 

The OPEC has agreed to increase production. But there are doubts that the OPEC can increase production without affecting spare capacity. That is, how much extra oil the countries can produce sustainably.

Both increasing oil prices and tariffs bring in the risk of higher inflation. Surging oil prices are already raising inflation in the US and Europe.

And there are concerns that higher than expected inflation could cause the US Federal Reserve to start increasing rates quicker than planned.

As we wrote before, to boost the economy after the 2008 crisis, the Fed lowered interest rates to record lows. They are now looking to normalise the economy by increasing rates.

The Fed has promised that the rate hikes will be gradual. They have increased rates twice this year and are planning to raise the rate another two times this year.

Will Inflation Get Out of Control?

But higher than expected inflation could throw a wrench in their plans. Trust me, inflation can get out of control fast.

Especially when you couple this with the recently approved US tax cuts.

In a world with record high debt, higher inflation and interest rates could bring a whole set of problems As the IMF noted:

‘[S]igns of firmer than-expected inflation in the United States could lead to a shift in market expectations of US interest rate hikes, which are currently well below those in the WEO baseline forecast. A sudden deterioration of risk appetite could trigger disruptive portfolio adjustments, accelerate and broaden the reversal of capital flows from emerging markets, and lead to further US dollar appreciation, straining economies with high leverage, fixed exchange rates or balance sheet mismatches.

In this ‘more fragile, under threat’ economy with a higher ‘potential for disappointments,’ the IMF has a recommendation. Especially for governments with high debt levels:

But with reduced slack and downside risks mounting, many countries need to rebuild fiscal buffers to create policy space for the next downturn and strengthen financial resilience to an environment of possibly higher market volatility.

That is, governments should start accumulating cash to prepare for the next downturn.

And investors should be doing the same. That is, paying off debt, and stocking up on cash.

All to prepare for the next downturn.

Best,

Selva Freigedo,
Editor, Markets & Money

PS: Author and economist Harry Dent predicted Japan’s 1989 collapse, the 2000 dotcom bust and the 2008 subprime flop. He now has a chilling warning for Australia.  To claim your copy of Zero Hour click here.


Selva Freigedo is an analyst with a background in financial economics. Born and raised in Argentina, she has also lived in Brazil, the US and Spain. She has seen economic troubles firsthand, from economic booms to collapses and the ravaging effects of hyperinflation, high unemployment, deposit freezes and debt default. Selva now writes from her vantage point here in Australia. She is lead Editor at the daily e-letter Markets & Money. And every week, she goes through each report and research note produced by our global network of trusted advisors to find the best investment opportunities for you in Australia and overseas. She packages these opportunities for you in Global Investor.


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