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Pressure to grow

The United States, the Eurozone and Japan are all set to continue on their slow recovery path. Economists speculate about the longevity of lower growth rates.

In Brief

  • The United States continue to lead the developed economies’ recovery.

  • Growth is gaining momentum in the lagging Eurozone.

  • We expect the U.S. Federal Reserve Board (Fed) to raise rates in the third quarter.

  • The European Central Bank (ECB) and the Bank of Japan stick to Quantitative Easing (QE).

  • Diverging monetary policies support the U.S. dollar.

  • No sell-off of government bonds before mid-2016.

  • Equities are boosted by low interest-rate environment.

" The developed countries remain on a solid growth path. In other times, this would not have justified rates close to zero. The reasons are currently being vigorously debated. "

On a moderate growth path

After the economic crisis in 2008 and 2009, the recovery seems to be on track. There is concern, however, from the slowdown of growth in industrialized countries. Tempering potential growth in industrialized economies might signal that consumers, companies and governments in developed markets must learn to live with meager growth rates for quite a while. “So what – why should we need more growth?”, many readers may wonder. The level of prosperity is high in the Western world, and a deceleration of economic growth seems to do no harm.

However, this train of thought would be fatal. A prolonged period of sluggish growth could have enormous implications. If economic growth falls short of productivity progress, companies will be able to produce their sales volumes with ever fewer staff. This will inevitably lead to rising unemployment. The pressure to increase productivity results from the level of interest rates. Companies must invest in order to renew their diminishing capital stock. The capital needed is provided by private households which cut consumption to do so. But hey want to be compensated for trimming back consumption by a positive real interest rate, i.e. the nominal interest rate adjusted for inflation. As a result, companies must produce more goods with the new capital stock and the same number of employees to be able to pay the real rates.

Relationship of interest rates and growth

As long as the real interest rate is positive, there is pressure to increase productivity and grow. But as recent history also shows, low or even slightly negative real interest rates are perfectly possible. This fuels the debate about whether real interest rates are too low for future growth or whether the interest-rate level is so low because industrial markets are entering a phase of lower economic growth. There is fierce debate among economists on whether we are on the brink of an era of low and meager growth. The term ‘secular stagnation,’ i.e. stagnation over a longer period, re-emerged. The first to kick off this discussion was Harvard economist Lawrence H. Summers.

After World War II, the Fed managed to halt recession by cutting short-term rates and to get the U.S. economy off the ground again. In 2009, just before the outbreak of the financial crisis, the Fed cut the federal funds rate to almost zero. But even this was not enough to give the U.S. economy a boost. The Fed additionally bought U.S. Treasuries on a massive scale so that interest rates also fell on the long end, and bond prices rose sharply. However, new bond buyers were deterred by the resultant low interest rates. After the end of quantitative easing (QE), U.S. bond yields started to rise again, but are still at a historically low level.

Summers therefore assumed that the propensity of private U.S. investors to buy bonds at low interest rates, thus lending money over a longer term, was low. The slack demand of bonds limits the further fall of interest rates. On the supply side, companies offer their bonds. Due to the unfavorable demographic situation, i.e. a stagnating or declining population and the uneven distribution of income – a shift of income towards households with a high savings and a low consumption rate – companies expect low growth for a prolonged period. They would therefore only invest if real interest rates fell even further.

This means that interest rates would have to decline further to strike a balance between the supply and demand of savings, thus suppressing investments necessary for an improvement of the labor market situation and long-term growth perspectives.

Low inflation

Source: Thomson Reuters Datastream, as of 6/12/15

Development of inflation
When inflation rates fall and nominal bond yields stay constant, real bond yields start rising. This emerged for the first time in 2008. Currently, inflation rates are declining in the United States, the Eurozone and Japan. The major central banks are watching on the sidelines with skepticism since higher real yields reduce the incentive to invest.

Ultra-expansionary monetary policy

Source: Thomson Reuters Datastream, as of 6/12/15

Real yields of 10-year government bonds
The asset-purchase programs conducted by major central banks resulted in nominally lower – and in real terms even negative – long-term bond yields. The central banks‘ objectives were to raise the volume of profitable capital expenditure in line with falling real bond yields, fuelling growth by rising investment activities.

Capital expenditure remains center-stage

A prominent critic of ‘secular stagnation’ is Ben Bernanke. Janet Yellen’s predecessor as chairman of the Federal Reserve still believes in the power of low interest rates: real rates of zero or even below will make any investment which renders a positive yield profitable. But even Bernanke must admit that despite the low level of real interest rates, the investment rate in the United States has recovered only very slowly since 2010.2

Carmen Reinhart and Kenneth Rogoff, two Harvard economists, also disagree with the concept of secular stagnation. They view highly indebted private households and companies as triggers for the financial crisis of 2007. Excessively low interest rates in the years up to 2007 had tempted many people to purchase homes and equities on credit. Prices on financial and property markets rose tremendously. The bubble burst, and prices fell. The home and equity values were suddenly lower than the loans taken out. A process of deleveraging therefore started in 2008 which continues to this day. As soon as this process is over, Reinhart and Rogoff believe that the recovery of developed markets will gain traction.3

In short: what we are experiencing is a poor level of investment activities in the industrialized countries resulting in a flattening of the potential growth trend. This holds not only true for the United States but also for the Eurozone and Japan. Potential growth is not only hampered by suboptimal investment but also by
demographic trends in the industrialized world (read more in the Focus topic July 2015).

Idle capacity

Sources: Thomson Reuters Datastream, U.S. Congressional Budget Office, as of 6/12/15

Growth and potential growth in the United States
In the first quarter of 2015, the real gross domestic product (GDP) of 16,264 billion U.S. dollars fell 426 billion U.S. dollars short of potential GDP. The underutilization of capacity has, however, significantly fallen in the last few years. U.S companies‘ propensity to invest should thus increase.

A glance at investment rates

We are currently observing a slight rebound of investment rates in the United States and the United Kingdom. The turning point might be near in the Eurozone. In Japan, investment activities have been boosted by a combination of government stimulus, QE and a massive devaluation of the yen in previous years. These are encouraging signs for a revitalization of capital expenditure.

The global economy should continue on its moderate growth path. We forecast a global growth rate of 3.5% for this year.4 In 2016, growth should accelerate slightly to 3.8%. But regional differences should be huge. The United States will continue to lead the industrialized world with a growth rate of 2.4% in 2015 and 3.1%
in 2016. One of the main drivers is likely to be consumer spending. Private households have significantly reduced their debt in relation to income in the last few years, thus creating more leeway for spending. Rising demand for consumer goods should boost expenditure.

Next is the United Kingdom with an expected growth of 2.3% in 2015, the Eurozone with 1.4% and Japan with 1.2%.5 Japan's economy stagnated last year. The massive devaluation of the yen was cancelled out by a consumption tax hike from 5 to 8% in April 2014, so the Japanese economy did not make any headway.
Despite the large government budget deficit, the Japanese government under Shinzo Abe therefore postponed the next tax hike to 2017, thus stimulating private consumption. The Japanese government also hopes for rising wages, although there are currently no indications of this. Our growth forecast for Japan is 1.2% in 2016.

Downward trend

Source: European Commission, as of 6/12/15

Development of gross investment in fixed assets
Growth is based on investment, i.e. the purchase of new machinery or the development of new products. A declining investment rate could result in slower growth in developed countries.

Eurozone overtakes Japan

Source: Thomson Reuters Datastream, as of 6/12/15

Real gross domestic products compared
The United States and the United Kingdom have both overcome the sharp downturn in 2008 and 2009. The Eurozone and Japan are on the brink of doing so. Based on our forecasts, the Eurozone should grow faster than Japan.

Accelerated growth in credit and money

We expect an acceleration of growth in the Eurozone from 0.9% last year to 1.4% this year. The economic momentum is simultaneously driven by several factors. First, the devaluation of the euro vs. the U.S. dollar should stimulate exports. Austerity measures, which have restricted growth in periphery countries such as Italy, Spain and Portugal, will be further loosened. Moreover, lending standards are becoming less restrictive. This leads to higher credit volumes and monetary expansion. Although yield spreads of government bonds from Italy, Spain and Portugal to Bunds have widened slightly since April 2015, they are still far below the levels reached in 2012 and 2013. This shows that investors assess the danger of another euro crisis as low.

Greece remains in the investor focus. The probability of a speculative spillover of the Greek crisis to other Eurozone members is low. Bankruptcy or a withdrawal of Greece from the Eurozone might well throw other countries’ government bonds into disarray. This should, however, be limited by ECB asset purchases.

One factor accounting for the shift in growth is the oil price. From mid-July 2014 to mid-January 2015, the price of a barrel of WTI oil fell from roughly 100 to 50 U.S. dollars. Although it has recovered by roughly 10 U.S. dollars in the last few months, it is still well below 2014 price levels. The major industrialized countries are the winners here. The increase in purchasing power resulting from lower oil prices has given an additional moderate impetus to growth.

End of the BRIC story

Among the losers of falling prices for energy and metals are commodity-producing emerging markets. Since the commodity sector is the most important sector in many of these countries, they will experience a severe slowdown in growth this year. This will also put an end to the BRIC story. In the past, commodity-exporting emerging markets used to benefit from growing demand from the industrializing emerging markets.

Brazil and Russia were among the beneficiaries of rising commodity prices which in their turn resulted from the growing appetite for commodities in India and China. Brazil and Russia are now feeling the pain, whereas India and China can rejoice that low commodity prices are bolstering their economic growth. After the implementation of several fiscal and monetary measures, China even managed to halt the deceleration of growth. In 2015, China’s real GDP is expected to grow by 6.8%, but it will have to pass the title of the world's fastest growing economy to India this year.6

Turtle cycle still intact

Global economic growth remains on track but the pace of growth continues to be modest. In 2015, global GDP is set to rise by 3.5% in real terms, with industrialized countries reporting significantly lower growth rates.6

This means that they are responsible for weaker global growth figures. The industrializing emerging markets in Asia remain the main drivers of the world economy. Emerging markets which are highly dependent on commodity exports should be among the losers this year.


1 Deutsche AWM forecast as of 6/16/15


2 Source: European Commission, as of 6/12/15


3 Source: Carmen M. Reinhart, Kenneth S. Rogoff: Growth in a Time of Debt. NBER Working Paper No. 15630, January 2010


4 all forecasts: Deutsche AWM forecast as of 6/16/15


5 all forecasts: Deutsche AWM forecast as of 6/16/15


6 Deutsche AWM forecast as of 6/16/15

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