Wells Fargo’s top economist Dr John Silvia weighs in on key issues in the US and China, from a hike in interest rates by the US Federal Reserve in December to China’s recent economic woes, declining Renminbi and five-year development plan
By Nan-Hie In
Key events in the coming months will be closely watched and followed, for they will have a significant impact on China and the United States among other markets globally. As a number of economically significant events has already taken place at the end of 2015, what are some of the latest trends that will affect the global economy in 2016?
Much attention has risen from the Federal Reserve’s meeting in December in which the US monetary policy took the direction of an increase in interest rates from near zero, although marginally, for the first time in almost a decade. Meanwhile, the International Monetary Fund has decided to include the Chinese currency, Renminbi (RMB), in the special drawing rights (SDR) basket, a potential game-changer for Mainland China.
Dr John E Silvia, Managing Director and Chief Economist at Wells Fargo, has precisely predicted back in early November [at the time of writing] that an interest rates hike by the US Federal Reserve in December was more than likely. And he was very optimistic about a landmark move by the IMF on the Chinese currency.
“Within the next three months to a year, [Renminbi] is going to be part of IMF’s special rates [basket] for China,” he noted at an AmCham luncheon late last year, while elaborating further on the economic impact of such move and providing an outlook for the world’s two largest economies.
The US economy
The fundamentals of the US economy look positive overall. On growth, the US economy – the world’s largest – has expanded by about 2 to 2.5 percent for the last four years, and Silvia predicts the trend to continue to 2016 at 2.5 percent GDP growth.
With less than a year to the 2016 US presidential election, a number of candidates on the campaign trail, including Jeb Bush and Chris Christie with ambitious plans to supercharge the economy, have touted greater promises of 3 to 4 percent growth, driven by a shift of national policy and spending. Silvia calls such talk “hooey.”
“It’s great politics but it has nothing to do with the economy; basically 2 or 2.5 percent is what it is,” he rebukes.
Meanwhile, the labor market continues to improve as the unemployment rate is down to around five percent. The Wells Fargo economist notes the labor force is undergoing a structural shift across the nation, as evidenced in areas such as Charlotte, North Carolina where there is a gap between well-paid professional services providers and manufacturing workers coming from an old textile industry which continues to struggle in the city.
Much data reflects this dichotomy between manufacturing and the services sector in the US. The Institute for Supply Management’s (ISM) Manufacturing Index, an official indicator of the nation’s manufacturing activity, recorded a mark of 50.2 in September. The mark of 50 is the line between growth and contraction. The recent reading suggests a marginal increase in activity.
According to Silvia, the manufacturing sector has been hurt by a stronger US dollar as American-made goods are more expensive to export abroad. The current conditions also make some US goods less competitive than those of other markets at an advantage with their currency exchange rates.
“The perception of slower global growth has also had an impact on orders and production in the manufacturing sector in the US,” he adds.
In contrast, the services sector in the US is doing better as the ISM Non-Manufacturing Index in September registered a mark of 56.9 – a trend Silvia attributes to the strength of the domestic consumer in 2015, which has been growing since 2010. “The phenomenally strong American consumer is in part because wages and salaries continue to improve,” he says.
As the nation continues to experience exceptionally low inflation and moderate wage and salary gains, these conditions have translated to real income gains which have helped American consumers this year, Silvia explains.
US inflation, one of the most important economic indicators at financial institutions like Wells Fargo, has averaged at less than two percent for 20 years, says Silvia. He foresees modest inflation to continue in the US at around 1.5 to 2 percent in the next two to three years.
The US, like Europe, will continue to struggle with bolstering inflation as a result of the current global trading environment which also leads to a stronger dollar and weak oil prices.
US Federal Reserve officials had previously indicated a target of inflation at 2 percent before embarking on a journey of raising interest rates. The stagnantly low inflation environment had in fact prompted the central bank’s decision to delay a hike, Silvia says, noting the interest rate remained near zero since the 2008 financial crisis.
“They thought inflation was going to be two percent in 2015, and gradually it came down to 1.4 percent,” he notes, adding that the central bank lowered its inflation expectation for the year.
As widely expected in the market, the US interest rates moved up 25 basis points after a decision by the US Federal Reserve policy-setting committee in mid-December. However, it is also quite possible that it be reversed in the near future, based on the Fed’s dot plot showcasing fund rates predictions for 2015 and beyond, published by members of Federal Open Market Committee.
“They have continued to lower it in the last three meetings [as of November] and they will probably lower it again,” Silvia says, referring to the data. “It will end up at around one percent perhaps by the end of 2016.”
“I’ve looked at the fundamentals, and economic growth doesn’t justify those numbers and neither does the inflation pattern,” he argues, adding that the rate hike would not be that bearish on the market.
Despite China’s recent volatility and concerns about an economic slowdown, Silvia remains optimistic. “China is in a big struggle trying to define a new normal that is more open in areas such as the currency and capital markets,” he says. “I take that these things as positives.”
Silvia also assesses China’s economy differently than that of the US and explains why he does not interpret volatility of China’s stock market with too much weight. In the US, equities and securities matter more to the overall economy, hence a larger focus on the stock market and its performance.
This, however, is not the case in China, he explains. “While the Chinese stock market is interesting and growing, the bigger deal in China are bank loans.”
China’s equity market is still “a youngster,” and turbulence is expected as the nation changes its margin requirements, Silvia points out. It is similar to the US stock market in the 1950s and 1960s when it went through growing pains and enacted changes in margin requirements. “It is going to take a while for China to fair out how the market operates,” he says.
Silvia pays attention to how a country finances its economic activity as a barometer of that particular economy. “Looking at bank finance is much more important [in China] as the country continues to liberalize capital controls, lower reserve requirements and so forth and that is quite a stimulus in this economy as oppose to the US,” he says.
Like many observers, Silvia is cautious about China’s manufacturing sector but is optimistic regarding its services sector, which has been expanding. Although China’s non-manufacturing Purchasing Managers’ Index has been decreasing in recent years, it recorded an overall expansion at 53.4 on a recent reading.
Noting the “remarkable stability” of China’s GDP growth in the last three to five years, Silvia projects the economy to expand by 6.2 to 6.3 percent in 2016 as China shifts away from manufacturing to a services-based economy. “Transitions can take anywhere from 5 to 20 years,” he says. While some countries such as Russia, Argentina and Brazil have never fully made the tradition, he expects China to be more successful.
The inclusion of RMB in the SDR basket will essentially allow the market to vote on China’s policies. “When China decides to do something in respect to public policy, you’ll see the exchange markets vote on whether they think such move is favorable or not for the currency and the economy,” Silvia says.
“China is going to be like the US, Europe, Japan and the UK in that it will have a more freely floating exchange rate, and that is going to be interesting.”
China’s Fifth Plenum in October has called for a five-year plan to double its 2010 GDP growth by 2020 as well as per-capita incomes of citizens, among other ambitious reforms to advance the nation. However, Silvia has doubts about some of the aggressive targets and cautions the possibility of overspending and misallocation or inefficient use of capital to achieve these ambitions.
“It is great to have ambitious goals, but the question you have to ask yourself is whether this is the old Soviet Union problem,” he says.
Nan-Hie In is a freelance journalist based in Hong Kong covering current affairs, lifestyle and entertainment in Asia. A regular contributor to local and international media outlets, she has written for the South China Morning Post, CNN (Business Traveller), the China Daily, Hongkong.Coconuts. co, Prestige and more.