Global Outlook 2013-14 􀂄 UBS

G lobal Outlook 2013-14
􀂄 Generally better, but not without risk
As is our autumn custom, we launch our Global Economic Outlook, including an
initiation of 2014 forecasts. Overall, we expect a gradual improvement in global
real GDP growth from a low point of 2.7% this year to 3.0% next year and 3.4% in
2014. Although growth rates in many parts of the world economy are expected to
improve over the next two years, a key theme is US cyclical leadership. Risks to
our forecasts remain in the form of the US ‘fiscal cliff’, a re-escalation of the
Eurozone crisis, a harder landing in China, or an energy price shock.
􀂄 Implications for interest and exchange rates
As recently reinforced by Fed Chairman Bernanke, the Fed is likely to remain
highly accommodative well into recovery. The implication is that policy rates will
remain very low over the forecast horizon. High levels of excess capacity and a
still-moderate pace of recovery suggests that bond yields, when they begin to move
higher, will do so gradually. The dollar should appreciate modestly, given better
US fundamentals.
􀂄 Update on de-leveraging
Private sector de-leveraging in the US is advanced, including in the financial,
household, and non-financial corporate sectors. Headwinds of US private sector
de-leveraging are therefore lessening. The same is not true in much of peripheral
Europe or the UK, which together with Eurozone structural adjustment suggests
continued growth restraint across much of the EU. The next big de-leveraging
resides in the US and Japanese public sectors (continental Europe is generally more
advanced in this dimension). Fiscal adjustment represents both a key risk factor for
global growth and an enduring source of global demand restraint in the years
ahead.
􀂄 American revival?
Lessening private-sector de-leveraging, improved competitiveness, and supply-side
innovations (for example in energy) suggest the US economy may be poised for
revival ahead of its peer group of advanced economies, but also amid a secular
slowing in the emerging complex. One implication is stronger capital inflows into
the US.

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Global economic outlook
Summary
Each autumn UBS economists review their outlook for the following year and
initiate forecasts for the year thereafter. In this note we present our 2013 global
outlook, and extend our forecast horizon to 2014.
In many respects, the outlook is familiar, perhaps distressingly so. Over the next
two years, the world economy will do well if it can muster trend-like growth.
Headwinds of de-leveraging, balance sheet repair and structural adjustment,
above all in Europe, are unlikely to lessen much in the coming quarters. Japan
remains mired in deflation and dependent on exports. Meanwhile, a mix of
cyclical, structural and policy impediments is likely to restrain growth in
emerging economies below the high rates of the past decade. Even in the US,
where growth prospects are arguably their brightest since the financial crisis
erupted in 2007, a guarded outlook and policy uncertainty will restrain growth to
near its potential rate, insufficient to make a rapid dent in the still-high US
unemployment rate. And even that outcome depends crucially on whether
politicians in Washington can agree to postpone or otherwise moderate the date
of US fiscal reckoning.
Still, there are some encouraging aspects to the outlook. Moderate growth amid
still-large reservoirs of spare capacity suggests little scope for inflation, barring
commodity supply shocks. The avoidance of global recession and subdued unit
labour costs ought to support continued high levels of corporate profitability,
particularly in developed economies. Moreover, gradual recovery accompanied
by stable inflation expectations ought to allow central banks to maintain current
accommodative policy stances for longer (and subsequently adjust them
gradually), limiting the possibility for monetary policy-induced market
dislocations in the period ahead. And technological progress continues to
manifest itself, above all in the US energy and technology sectors.
Risks abound, not just to the downside. Among the more significant adverse
shocks remains the possibility that politicians in Washington will not be able to
find common ground on matters of taxation and spending, sending the US and
global economy off the much-discussed fiscal cliff. We suspect that common
sense (i.e., self-interest) will lead to a compromise that turns the cliff into a mere
ledge. Disruptions to energy supply are a further source of downside to global
growth, as would be a sharp re-escalation of Eurozone tensions. And China
could still experience a hard landing, particularly if property and external
weaknesses result in a greater degree of domestic banking stress.
To the upside, the evidence suggests that US private sector de-leveraging is
well-advanced. A recovering US housing market, rising bank credit, and falling
household sector debt servicing are all elements of that story. To the extent that
political and policy uncertainties, which have restrained business spending in
2012, begin to recede, the stage could be set for a more rapid pace of US growth,
supported and reinforced by employment, capital expenditure, housing and
credit growth, and underpinned by easy Fed policy and higher asset prices.
Coupled with improved international competitiveness and innovations in

domestic energy production and technological progress, a ‘US revival’ could
well become the big surprise of the next two years.
In what follows we outline our forecasts and broader assessment of the world
economy in the following sections:
􀁑 Forecast overview
􀁑 Risks to the forecast
􀁑 Update on de-leveraging
􀁑 American revival?
Forecast overview
After consecutive years of decelerating global GDP growth since 2010, we
anticipate that both 2013 and 2014 will register modest improvement relative to
the recent low point for global growth registered in mid-2012. Specifically,
global real GDP growth this year is expected to come in at just 2.7%, down from
3.2% in 2011 and 4.2% in 2010. Next year, however, we forecast a rate of global
real GDP growth of 3.0%, followed by 3.4% in 2014.


To be sure, the average annual rate of forecasted growth over the next two years
is roughly in line with the long-term average rate of world GDP growth and
most probably close to its trend rate as well (Chart 1). Above all, that means that
swathes of excess capacity in global product and labour markets will not be
rapidly absorbed in the next two years. The old adage rings true: Inflation results
from ‘too much money chasing too few goods’. In its current rendition the
verdict is likely to be still-low inflation. Despite the printing prowess of central
banks, excess global capacity is likely to act as a restraint on broad-based
increases in most prices and wages. The intense demands for liquidity from the
European banking sector amidst ongoing restructuring and restraint, moreover,
seems likely to constrain the inflation implications of the ECB’s balance sheet
expansion as well.


Within the detail, the outlook is one of cyclical divergence. Among advanced
economies, the US is likely to re-occupy its familiar position as growth leader.
Next year’s forecasted 2.3% calendar year average US GDP growth rate masks
the underlying improving dynamic of the economy. On a Q4 2013-on-Q4 2012
basis, we project a faster 2.7% US GDP growth rate. Moreover, as we detail
below the headwinds of balance sheet repair and deleveraging in the US private
sector are lessening. In 2014 we expect US calendar year average GDP growth
to reach 3.0%. Underscoring the sense that the US economy is poised for the
better, is the contribution to forecasted GDP growth in the next two years from
private sector final demand, both consumer spending and business investment


Nor are there significant private sector imbalances that might impede the US
recovery. The contribution to US growth from inventories has been weak, as
businesses have kept a close check on production relative to final demand—destocking
is a small risk, per se. US household sector indebtedness continues to
fall relative to disposable income, as does the share of income devoted to
meeting household sector financial obligations (Charts 3-4, above). Lastly,
corporate profitability, which jumped from 2009-2011, remains at high levels,
helping to keep business borrowing costs low and generating sufficient cash
flows to support capital spending and hiring. Recent weakness in business
spending is not fundamental—instead, it most probably reflects poor confidence
in policy-making.



As we recently noted, other parts of the world economy also appear at an
inflection point, with slowdowns ending, even if more rapid growth may not yet
be evident. That appears to be true in China and other parts of Asia, where first
signs of a bottoming in exports are visible. At the same time, China’s property
market slowdown also appears to be ending, not coincidentally as economywide
credit growth begins to pick up. In Brazil, too, solid real income formation,
supported by credit growth, is producing a pick-up in consumer spending—we
expect growth in Brazil to move back up to 4.5% next year.
Still, recoveries across the world economy are not uniform—Europe and Japan
remain notable laggards. In Europe’s case, fiscal retrenchment, structural
adjustment, and banking sector weakness in many Eurozone countries and the
UK are the sources of stagnation, at best, and deep recession, at worst. While
some of those headwinds may lessen in the coming two years, they will remain
significant drags on economic activity in the EU over the forecast horizon, in
part because of the inability or unwillingness of the healthier parts of Europe
(read: Germany) to generate offsetting growth impulses. In 2013 we believe
Eurozone GDP growth will stagnate (0.1%), with moderate pickup projected in
2014 (0.9%)
In Japan, deflation, a strong yen, weak export markets, poor corporate
profitability and demographic challenges continue to restrain what potential for
growth exists. Japan’s growth will be modest in the next two years—for each of
the next two years we forecast Japanese real GDP growth of 1.8%. In 2014, a
planned hike in consumption taxes poses significant downside risks to activity.
As a consequence of developed economy divergence, we anticipate a generally
stronger US dollar over the forecast horizon. Specifically, our year-end dollar
forecasts versus the euro are 1.20 at the end of 2013 and 1.15 by end 2014. The
profile is similar for the yen, which is expected to depreciate to USD/JPY 85 at
the end of next year and USD/JPY 90 by end 2014. After considerable real
exchange rate appreciation recent years and against a more subdued growth
backdrop, we do not anticipate significant further appreciation of major
emerging economy currencies against the dollar


Monetary policy settings in developed economies are apt to remain
accommodative over the forecast horizon. Ongoing de-leveraging in Europe,
including in the UK, and the associated deflationary impacts suggest that neither
the ECB nor the Bank of England is likely to lift policy rates over the next two
years. The persistence of deflationary pressures in Japan implies the same for
the Bank of Japan. Asset purchase programmes are likely to remain in place in
most major developed economies, including the US, notwithstanding our
relatively upbeat assessment of US economic prospects. The Fed has committed
itself to a period of prolonged easing until the economy achieves meaningful
improvement, including a substantial reduction in unemployment and a closing
of the output gap.
Still, by 2014, as US labour market conditions improve and the economy moves
closer to its potential growth rate, the Fed may modify its language as well as
the size of its asset purchase program. At some point, perhaps by 2014, the Fed
may even allow its balance sheet to shrink by not replacing maturing securities.
Such signalling would, of course, be akin to a moderate tightening of monetary
conditions, including via its impact on long-term US Treasury yields.