Hope springs for a global recovery

The latest figures from China and the US suggest green shoots, but commodity prices and bond yields are the ones to watch for a real recovery of the global economy.

There were a few flickers of light in the global economic news over the weekend with a decent jobs report in the US and a higher turn in a range of key Chinese data.

The Sunday data dump out of China suggests the world’s second largest economy is about to pick up from the three-year slowdown with industrial production and retail spending stronger than expected in November. Fixed asset investment was also strong as the business investment growth slowly recovers from a nine-year low.

At the same time, China’s annual inflation rate edged higher to 2.0 per cent in the year to November from 1.7 per cent in the year to October, while producer prices fell sharply at an annual pace of 2.2 per cent.

While the rate of economic expansion in China is still well below the breakneck speed of 2010 and early 2011, recent trends suggest GDP growth in 2013 is on track to recover to a decent 8 to 8.5 per cent pace after slowing to around 7.5 per cent in 2012. It is not, at this stage, a strong pick-up but in a world of general economic gloom, such a solid expansion in China would lift many other countries, including Australia, with it.

The news of a turn higher in the Chinese economy follows another respectable labour market report in the US on Saturday morning. There was a solid rise in employment and the unemployment rate dropped to a four year low of 7.7 per cent. A fall in the participation rate, low wages growth and weak hours worked took some gloss off the otherwise favourable news. In recent weeks, there has been further confirmation that previously depressed housing market in the US is also recovering, with prices, construction, home builders confidence and sales all trending higher.

If the US, which is still the world’s largest economy, can register even a moderate expansion in 2013 with GDP growth around 2.5 per cent at the same time that the Chinese economy picks up to an 8 per cent pace or even a little stronger, there should be enough positive momentum to counter what looks to be chronic weakness in the eurozone.

There remains a fly in the ointment from these improving pieces of economic news - inflation and commodity prices. These indicators of economic strength are consistent with sluggish global conditions.

Even the up-tick in China’s inflation rate in November was modest and the rise was squarely linked to higher food prices which may dissipate in the months ahead once softer global commodity prices feedback into the local inflation rate. As it is, the annual rise of 2.0 per cent in inflation is low for an economy in China’s stage of industrialisation.

Indeed, China’s low inflation rate fits with other information showing global inflation trends locked in at low levels. Inflation in the G7 countries remains extremely low reflecting a world economy still growing below trend, with huge amounts of spare capacity and a looming glut of many commodities. It is an era where global interest rates are likely to remain very low for many years to come.

The various measures of commodity prices, which are perhaps the best indicator of future inflation risks, remain subdued.

The Thomson Reuters/Jefferies CRB Commodity Index, for example, remains around 10 per cent lower than in September and has weakened in recent weeks as the US dollar has depreciated. Compared with the pre-GFC peak in 2008, the CRB index is over 35 per cent lower, which suggests either demand, is weak or supply is too strong or there is a mix of both influences at play.

The low global inflation climate is also showing up in persistent low yields for government bonds. So confident are investors that low inflation in entrenched or even that there is some risk of deflation, 10-year government bond yields are 0.71 per cent in Japan, 1.30 per cent in Germany, 1.62 per cent in the US and around 3.1 per cent in Australia where the economy is still growing at a reasonable pace. In real terms, yields are negative in Germany and the US.

While there are some hints of better economic news coming in China in particular and to some extent in the US, it is not showing up in the re-pricing on bond yields or in commodity prices. Only when bond yields break higher and commodity prices sustain a decent rise should there be complete confidence on a true global recovery.

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