Graphic content – April; the real reason why the global economy is stalling?

Mike Riddell
Written by

20th April 2018

The global economy had been ripping since early last summer, at least relative to the lacklustre growth seen post-2008. But there has been strong evidence of a slowdown in the past couple of months, particularly in the Eurozone, where economic data has disappointed (lofty) expectations by close to the most on record.

Most analysts have argued that weak data was due to poor weather, and is therefore temporary. There will be some truth to this, nevertheless it’s always bemusing why forecasters seem consistently unable to adjust their forecasts, when they know exactly what the weather was.

Others have argued that the global economy, and especially the Eurozone, was growing far above long-term trend in H2 2017, and that some degree of normalisation was therefore inevitable. This may be correct too, although again, why was it not factored into prior forecasts?

Another explanation that receives far less airtime is that the global slowdown may be due to commodities, however not in the way most expect.

Commodity prices are usually seen as a global growth barometer. Higher commodity prices tend to be viewed as indicative of strengthening global aggregate demand, weaker commodity prices as an early warning signal of a cyclical slowdown.

But for the global economy, the chart below suggests that the relationship in fact works the other way around. The blue line plots global manufacturing PMI, arguably the broadest coincident indicator of global economic activity. The purple line is a smoothed measure of a basket of global commodities, but inverted, and advanced by 5 months.

Strong commodity prices suggest weaker growth ahead

Strong commodity prices suggest weaker growth ahead

Source: Allianz Global Investors, Bloomberg, 01/01/1998-31/03/2018.

Global commodity prices have historically been a reliable lead indicator for global growth, where sharp rises in commodity prices have usually been followed by weaker economic growth 5 months later, and where a slump in commodity prices has historically been followed by an economic rebound. Extreme commodity price moves can be dangerous; global recessions of the past 50 years have been preceded by a spike in the oil price.

The relationship between commodities and PMI makes sense if you consider that commodities are an input cost for most companies, where higher commodity prices squeeze profit margins, which will eventually cause a reduction in investment. And for households, a higher oil price in particular pushes up headline inflation, and therefore reduces real incomes. The chart suggests the opposite holds true too.

So a significant reason why global growth has slowed may simply be due to the near 10%+ jump in commodity prices we saw from the end of June 2017 to the end of January 2018. If this is the case, then you’d expect to see global economic momentum gradually recover from here, given that commodity prices overall are exactly where they ended January. A reversal of the recent bad weather should also help.

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