A potential Chinese yuan devaluation and the UK/EU referendum are just two of the major risks facing the global economy. That was the view of Paul Lambert in a presentation at the BNY Mellon Investment Conference 2016 in Milan.*
Lambert said a UK exit from the EU would create “an enormous shock for the UK, The European and the global economy”, while a Chinese devaluation would lead to further inflation weakness. In either case, investors are preparing for worst-case scenarios now – and this is driving up volatility across asset classes.
On the question of China, Lambert noted how massive fiscal stimulus enacted after the global financial crisis had convinced investors the country was “bullet-proof” and “could do whatever was needed to create the right conditions for growth”. This no longer seems to be the case. “Chinese currency reserves are falling rapidly and at some point the decision will be made to devalue the yuan – when this happens we expect it to unleash another wave of deflation around the world as the cost of manufacturing goods falls further.”
Elsewhere, Lambert outlined some trends highlighting how far the post-financial crisis world has deviated from historic norms. He noted how, in the aftermath of previous recessions, the US Federal Reserve (FED) generally tended to begin raising interest rates once manufacturing PMI data recovered to above 50 (see Figure 1). “In the current economic cycle, that point has been and gone, while the US economy is close to full employment. And yet the FED has only just started raising rates now.”
The reason, he said, is the lacklustre pace of the recovery – which is weaker than post-recession recoveries in 1957, 1973, 1980, 1990, 2001 and 2007 (see Figure 2). Taking an analogy from physics, he noted how Hook’s Law would suggest an equal and opposite reaction for any downturn: that the bigger the recession the bigger the bounce back. “But with this recovery that’s not the case,” he said. “This time something’s different.”
As a result, he said, there has been a “growth wobble” in recent months as some of the more positive trends that buoyed markets – such as increased corporate profits – begin to retreat. Investors are now worried that central banks have “run out of ammunition” to boost growth; but they are also concerned about deflation as oil prices and other commodities continue to slump in response to oversupply.
And yet, according to Lambert, the current economic backdrop should be cause for optimism rather than pessimism. “Falling oil prices should be good for the global economy and central banks are generally cutting rather than raising rates. In other words, the economic background is as good as it’s going to get and still investors are worried. Perhaps they are right. Perhaps worse is yet to come.”
*The BNY Mellon Investment Conference Milan 2016 is an annual conference and showcases our boutiques from around the world with a focus on fixed income and alternatives. This year’s topic: Disruptive forces: True disruptors are creators and entrepreneurs first – not the other way around. Our fund managers and external contributor explored disruptive forces in the world of investments. On the agenda also how investments are affected by political changes, emerging market debt, liquidity and regulation. The Fund managers took part in a lively investment debates on the main platform and presented a range of investment disciplines in the boardroom sessions.