Tighter times

Are we ever satisfied? It doesn’t seem so. For years humanity has been clamoring that there has not been enough growth. Now it seems there is too much. It’s an instant flip that is now focused on how tight things are getting. The labour market is tightening, and so is industrial capacity. We’re just hitting our stride, and we are bursting at the seams. What does it mean for the forecast?

On the face of it, the numbers are a bit scary. Unemployment rates in both the US and Europe are at or very close to cyclical lows. Industrial capacity utilization in the US is high, and in recent months is rising. In Europe, the same measure has been surging since mid-2016, and is fast moving in on previous peak levels. While these are good problems to have, they do look like a classic late-cycle burst that in the past has never ended well. Tightness inevitably results in inflation, leading to the ultimate tightening of interest rates. 

Doomsayers already have their recession clocks set and humming. The most basic argument is timing: it has been about 10 years since the last one, and we are due. More sophisticated pundits scan the indicators, and come to the same conclusion. But dig a bit deeper, and there are strong counter-arguments.

First, there’s an army of potential workers sitting on the sidelines, thanks to years of sluggish growth. Nascent strengthening is bringing them back, but there is lots of room for further growth.

Second, capacity is tight because years of slow growth led to chronic under-investment. Tightening capacity – brought on by a sustained torrent of new orders – should lead to a ramp-up of investment, and easing of the production pressures.

A third factor is advancing technology, which is daily enabling us to get more out of both existing labour supply and current industrial capacity.

A fourth and often forgotten factor is the very obvious presence of pent-up demand. Various measures strongly suggest that in both the US and Western Europe, the housing, non-residential construction and consumer sectors have not yet fully recovered, and indeed have a long way to go before conditions are fully normalized.

For these reasons, EDCs most recent Global Economic Outlook is bullish about the near-term outlook. Our forecast calls for the US economy to rise by more than 3 per cent both this year and next, a more aggressive outlook than most. Likewise, we see the Euro Area economies collectively rising by 2.5 per cent this year and 2.1 per cent in 2019, amounting to the best 3-year stretch of growth in over a decade. This growth will enable emerging markets to continue pumping out impressive numbers: China is forecast to average 6.5 per cent growth this year and 6.4 per cent next year, while India will see 7.5 per cent in 2018, and an increase to 7.6 per cent in 2019. This will help to push all emerging markets to growth of 4.8 per cent this year, and 4.7 per cent in 2019.

This tightening environment is expected to put pressure on non-commodity prices. Pressure will be greatest in labour markets and prices of finished goods. To be clear, though, this is not late-cycle runaway inflation; rather, it is a signal to markets of the need to increase hiring activity and expand existing production facilities. It does mean that tightening will spread to another realm: interest rates.

Developed markets, principally the US, are feeling this already. Consumers and businesses alike will be weaning themselves off their dependence on cheap credit. Already, forms appear to be refinancing long-term obligations in advance of the anticipated run-up in rates. This will hit emerging markets differently. There, high-interest bonds have attracted yield-hungry investors for years, making capital much more available than usual. That is expected to end, and emerging market yields are steepening already. Those that have locked in long-term lending at lower rates will weather the change much better than others.

Global conditions are serving up attractive opportunities for Canada. Exports will rise 5 per cent this year and 4 per cent in 2019, leveraging higher growth in traditional markets and diversifying further into the emerging world. And in a rate-tightening environment where in general, financiers are more skittish than in the last cycle, there are also abundant opportunities to get more involved in the lending and credit insurance arenas. Now is a ‘go for it’ moment!